The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Apeloa Pharmaceutical Co.,Ltd (SZSE:000739) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 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 Apeloa PharmaceuticalLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Apeloa PharmaceuticalLtd had debt of CN¥939.9m, up from CN¥886.0m in one year. But on the other hand it also has CN¥3.89b in cash, leading to a CN¥2.95b net cash position.

A Look At Apeloa PharmaceuticalLtd's Liabilities

We can see from the most recent balance sheet that Apeloa PharmaceuticalLtd had liabilities of CN¥6.48b falling due within a year, and liabilities of CN¥274.9m due beyond that. Offsetting this, it had CN¥3.89b in cash and CN¥2.40b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥459.6m.

Since publicly traded Apeloa PharmaceuticalLtd shares are worth a total of CN¥19.2b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Apeloa PharmaceuticalLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Apeloa PharmaceuticalLtd saw its EBIT decline by 2.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Apeloa PharmaceuticalLtd 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. While Apeloa PharmaceuticalLtd 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, Apeloa PharmaceuticalLtd produced sturdy free cash flow equating to 59% 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 look at a company's total liabilities, it is very reassuring that Apeloa PharmaceuticalLtd has CN¥2.95b in net cash. So we don't have any problem with Apeloa PharmaceuticalLtd's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Apeloa PharmaceuticalLtd .

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.