David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Sichuan Huiyu Pharmaceutical Co., Ltd. (SHSE:688553) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Sichuan Huiyu Pharmaceutical's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Sichuan Huiyu Pharmaceutical had debt of CN¥675.3m, up from CN¥201.6m in one year. But it also has CN¥2.72b in cash to offset that, meaning it has CN¥2.04b net cash.

A Look At Sichuan Huiyu Pharmaceutical's Liabilities

We can see from the most recent balance sheet that Sichuan Huiyu Pharmaceutical had liabilities of CN¥1.13b falling due within a year, and liabilities of CN¥44.5m due beyond that. Offsetting this, it had CN¥2.72b in cash and CN¥63.5m in receivables that were due within 12 months. So it actually has CN¥1.61b more liquid assets than total liabilities.

This excess liquidity suggests that Sichuan Huiyu Pharmaceutical is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Sichuan Huiyu Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Sichuan Huiyu Pharmaceutical turned things around in the last 12 months, delivering and EBIT of CN¥88m. There's no doubt that we learn most about debt from the balance sheet. But it is Sichuan Huiyu Pharmaceutical's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sichuan Huiyu Pharmaceutical may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent year, Sichuan Huiyu Pharmaceutical recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sichuan Huiyu Pharmaceutical has net cash of CN¥2.04b, as well as more liquid assets than liabilities. So we don't think Sichuan Huiyu Pharmaceutical's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Sichuan Huiyu Pharmaceutical has 3 warning signs (and 1 which is potentially serious) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.