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 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 Shandong Boan Biotechnology Co., Ltd. (HKG:6955) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shandong Boan Biotechnology's Debt?

As you can see below, at the end of December 2023, Shandong Boan Biotechnology had CN¥396.2m of debt, up from CN¥293.3m a year ago. Click the image for more detail. However, it also had CN¥201.9m in cash, and so its net debt is CN¥194.3m.

How Healthy Is Shandong Boan Biotechnology's Balance Sheet?

According to the last reported balance sheet, Shandong Boan Biotechnology had liabilities of CN¥653.3m due within 12 months, and liabilities of CN¥350.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥201.9m as well as receivables valued at CN¥276.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥525.5m.

Since publicly traded Shandong Boan Biotechnology shares are worth a total of CN¥4.78b, 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. 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 Shandong Boan Biotechnology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Shandong Boan Biotechnology wasn't profitable at an EBIT level, but managed to grow its revenue by 20%, to CN¥618m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Shandong Boan Biotechnology produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥130m. 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. Another cause for caution is that is bled CN¥363m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Shandong Boan Biotechnology you should know about.

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.