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.' 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. Importantly, Wanbangde Pharmaceutical Holding Group Co., Ltd. (SZSE:002082) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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.

What Is Wanbangde Pharmaceutical Holding Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Wanbangde Pharmaceutical Holding Group had CN¥948.2m of debt in September 2024, down from CN¥1.09b, one year before. On the flip side, it has CN¥95.8m in cash leading to net debt of about CN¥852.4m.

A Look At Wanbangde Pharmaceutical Holding Group's Liabilities

According to the last reported balance sheet, Wanbangde Pharmaceutical Holding Group had liabilities of CN¥1.29b due within 12 months, and liabilities of CN¥211.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥95.8m as well as receivables valued at CN¥1.04b due within 12 months. So it has liabilities totalling CN¥365.1m more than its cash and near-term receivables, combined.

Since publicly traded Wanbangde Pharmaceutical Holding Group shares are worth a total of CN¥4.01b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Wanbangde Pharmaceutical Holding Group's net debt is 4.3 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 1k times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Notably, Wanbangde Pharmaceutical Holding Group's EBIT launched higher than Elon Musk, gaining a whopping 140% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Wanbangde Pharmaceutical Holding Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Wanbangde Pharmaceutical Holding Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Wanbangde Pharmaceutical Holding Group is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Wanbangde Pharmaceutical Holding Group is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. We've identified 3 warning signs with Wanbangde Pharmaceutical Holding Group (at least 1 which is significant) , 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.