Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Hua Medicine (Shanghai) Ltd. (HKG:2552) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hua Medicine (Shanghai)

What Is Hua Medicine (Shanghai)'s Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Hua Medicine (Shanghai) had CN¥162.7m of debt, an increase on none, over one year. But on the other hand it also has CN¥881.3m in cash, leading to a CN¥718.6m net cash position.

How Healthy Is Hua Medicine (Shanghai)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hua Medicine (Shanghai) had liabilities of CN¥256.5m due within 12 months and liabilities of CN¥676.9m due beyond that. Offsetting this, it had CN¥881.3m in cash and CN¥25.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥26.6m.

This state of affairs indicates that Hua Medicine (Shanghai)'s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥2.34b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Hua Medicine (Shanghai) boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hua Medicine (Shanghai)'s ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

While it hasn't made a profit, at least Hua Medicine (Shanghai) booked its first revenue as a publicly listed company, in the last twelve months.

So How Risky Is Hua Medicine (Shanghai)?

While Hua Medicine (Shanghai) lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥115m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. For instance, we've identified 1 warning sign for Hua Medicine (Shanghai) that you should be aware of.

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.