Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Guangzhou Wondfo Biotech Co.,Ltd (SZSE:300482) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Guangzhou Wondfo BiotechLtd's Debt?

The chart below, which you can click on for greater detail, shows that Guangzhou Wondfo BiotechLtd had CN¥559.6m in debt in March 2024; about the same as the year before. But on the other hand it also has CN¥2.18b in cash, leading to a CN¥1.62b net cash position.

How Healthy Is Guangzhou Wondfo BiotechLtd's Balance Sheet?

We can see from the most recent balance sheet that Guangzhou Wondfo BiotechLtd had liabilities of CN¥455.5m falling due within a year, and liabilities of CN¥694.0m due beyond that. Offsetting these obligations, it had cash of CN¥2.18b as well as receivables valued at CN¥802.9m due within 12 months. So it actually has CN¥1.83b more liquid assets than total liabilities.

This excess liquidity suggests that Guangzhou Wondfo BiotechLtd is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Guangzhou Wondfo BiotechLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Guangzhou Wondfo BiotechLtd has seen its EBIT plunge 13% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Guangzhou Wondfo BiotechLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Guangzhou Wondfo BiotechLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Guangzhou Wondfo BiotechLtd produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangzhou Wondfo BiotechLtd has CN¥1.62b in net cash and a decent-looking balance sheet. So we don't have any problem with Guangzhou Wondfo BiotechLtd's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Guangzhou Wondfo BiotechLtd you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com