Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Zhejiang Medicine Co., Ltd. (SHSE:600216) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is Zhejiang Medicine's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Zhejiang Medicine had debt of CN¥851.2m, up from CN¥801.2m in one year. However, it does have CN¥1.87b in cash offsetting this, leading to net cash of CN¥1.02b.

How Strong Is Zhejiang Medicine's Balance Sheet?

According to the last reported balance sheet, Zhejiang Medicine had liabilities of CN¥2.39b due within 12 months, and liabilities of CN¥458.2m due beyond 12 months. On the other hand, it had cash of CN¥1.87b and CN¥1.79b worth of receivables due within a year. So it actually has CN¥821.4m more liquid assets than total liabilities.

This surplus suggests that Zhejiang Medicine has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Zhejiang Medicine has more cash than debt is arguably a good indication that it can manage its debt safely.

Shareholders should be aware that Zhejiang Medicine's EBIT was down 98% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zhejiang Medicine can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Zhejiang Medicine 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. During the last three years, Zhejiang Medicine burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Medicine has net cash of CN¥1.02b, as well as more liquid assets than liabilities. Despite the cash, we do find Zhejiang Medicine's EBIT growth rate concerning, so we're not particularly comfortable with the stock. 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. To that end, you should be aware of the 2 warning signs we've spotted with Zhejiang Medicine .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.