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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Hebei Changshan Biochemical Pharmaceutical Co., Ltd. (SZSE:300255) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Hebei Changshan Biochemical Pharmaceutical

What Is Hebei Changshan Biochemical Pharmaceutical's Debt?

As you can see below, at the end of June 2023, Hebei Changshan Biochemical Pharmaceutical had CN¥2.64b of debt, up from CN¥2.13b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥554.6m, its net debt is less, at about CN¥2.09b.

How Strong Is Hebei Changshan Biochemical Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Hebei Changshan Biochemical Pharmaceutical had liabilities of CN¥1.72b due within a year, and liabilities of CN¥1.29b falling due after that. On the other hand, it had cash of CN¥554.6m and CN¥338.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.11b.

Given Hebei Changshan Biochemical Pharmaceutical has a market capitalization of CN¥12.4b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hebei Changshan Biochemical Pharmaceutical will need earnings to service that debt. 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 Hebei Changshan Biochemical Pharmaceutical had a loss before interest and tax, and actually shrunk its revenue by 25%, to CN¥2.0b. To be frank that doesn't bode well.

Caveat Emptor

While Hebei Changshan Biochemical Pharmaceutical's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥147m at the EBIT level. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥222m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. 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. For instance, we've identified 3 warning signs for Hebei Changshan Biochemical Pharmaceutical that you should be aware of.

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.