Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Consun Pharmaceutical Group Limited (HKG:1681) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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 think about a company's use of debt, we first look at cash and debt together.

What Is Consun Pharmaceutical Group's Debt?

As you can see below, Consun Pharmaceutical Group had CN¥507.7m of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥3.58b in cash to offset that, meaning it has CN¥3.07b net cash.

How Strong Is Consun Pharmaceutical Group's Balance Sheet?

The latest balance sheet data shows that Consun Pharmaceutical Group had liabilities of CN¥1.39b due within a year, and liabilities of CN¥112.5m falling due after that. Offsetting this, it had CN¥3.58b in cash and CN¥274.1m in receivables that were due within 12 months. So it actually has CN¥2.36b more liquid assets than total liabilities.

This luscious liquidity implies that Consun Pharmaceutical Group's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Consun Pharmaceutical Group has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Consun Pharmaceutical Group grew its EBIT by 13% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Consun Pharmaceutical Group 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Consun Pharmaceutical Group 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. Over the last three years, Consun Pharmaceutical Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Consun Pharmaceutical Group has CN¥3.07b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥833m, being 104% of its EBIT. So we don't think Consun Pharmaceutical Group's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Consun Pharmaceutical Group you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.