Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Nanjing King-Friend Biochemical Pharmaceutical Co.,Ltd. (SHSE:603707) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Nanjing King-Friend Biochemical PharmaceuticalLtd's Net Debt?

As you can see below, Nanjing King-Friend Biochemical PharmaceuticalLtd had CN¥2.68b of debt at June 2024, down from CN¥3.25b a year prior. However, it does have CN¥2.24b in cash offsetting this, leading to net debt of about CN¥432.6m.

How Strong Is Nanjing King-Friend Biochemical PharmaceuticalLtd's Balance Sheet?

According to the last reported balance sheet, Nanjing King-Friend Biochemical PharmaceuticalLtd had liabilities of CN¥3.08b due within 12 months, and liabilities of CN¥637.4m due beyond 12 months. On the other hand, it had cash of CN¥2.24b and CN¥1.31b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥170.3m.

This state of affairs indicates that Nanjing King-Friend Biochemical PharmaceuticalLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥21.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Nanjing King-Friend Biochemical PharmaceuticalLtd'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.

Over 12 months, Nanjing King-Friend Biochemical PharmaceuticalLtd made a loss at the EBIT level, and saw its revenue drop to CN¥3.8b, which is a fall of 6.7%. We would much prefer see growth.

Caveat Emptor

Importantly, Nanjing King-Friend Biochemical PharmaceuticalLtd had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥481m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of CN¥409m into a profit. So we do think this stock is quite risky. For riskier companies like Nanjing King-Friend Biochemical PharmaceuticalLtd I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.