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, Hainan Shuangcheng Pharmaceuticals Co., Ltd. (SZSE:002693) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hainan Shuangcheng Pharmaceuticals

What Is Hainan Shuangcheng Pharmaceuticals's Net Debt?

As you can see below, Hainan Shuangcheng Pharmaceuticals had CN¥166.0m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥91.3m in cash offsetting this, leading to net debt of about CN¥74.6m.

How Strong Is Hainan Shuangcheng Pharmaceuticals' Balance Sheet?

We can see from the most recent balance sheet that Hainan Shuangcheng Pharmaceuticals had liabilities of CN¥273.4m falling due within a year, and liabilities of CN¥11.2m due beyond that. Offsetting these obligations, it had cash of CN¥91.3m as well as receivables valued at CN¥30.2m due within 12 months. So it has liabilities totalling CN¥163.0m more than its cash and near-term receivables, combined.

Since publicly traded Hainan Shuangcheng Pharmaceuticals shares are worth a total of CN¥3.88b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. There's no doubt that we learn most about debt from the balance sheet. But it is Hainan Shuangcheng Pharmaceuticals'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 Shuangcheng Pharmaceuticals had a loss before interest and tax, and actually shrunk its revenue by 3.1%, to CN¥259m. We would much prefer see growth.

Caveat Emptor

Importantly, Hainan Shuangcheng Pharmaceuticals had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥53m at the EBIT level. 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¥36m of cash over the last year. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Hainan Shuangcheng Pharmaceuticals (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.