Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Hainan Poly Pharm. Co., Ltd (SZSE:300630) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Hainan Poly Pharm Carry?

As you can see below, Hainan Poly Pharm had CN¥2.72b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥331.4m in cash, and so its net debt is CN¥2.39b.

How Strong Is Hainan Poly Pharm's Balance Sheet?

According to the last reported balance sheet, Hainan Poly Pharm had liabilities of CN¥1.39b due within 12 months, and liabilities of CN¥2.06b due beyond 12 months. Offsetting this, it had CN¥331.4m in cash and CN¥1.13b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.99b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Hainan Poly Pharm has a market capitalization of CN¥4.81b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hainan Poly Pharm'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.

In the last year Hainan Poly Pharm wasn't profitable at an EBIT level, but managed to grow its revenue by 50%, to CN¥1.3b. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Even though Hainan Poly Pharm managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. To be specific the EBIT loss came in at CN¥46m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥322m of cash over the last year. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Hainan Poly Pharm (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.