Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Hunan Er-Kang Pharmaceutical Co., Ltd (SZSE:300267) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 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. 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.

What Is Hunan Er-Kang Pharmaceutical's Debt?

The image below, which you can click on for greater detail, shows that Hunan Er-Kang Pharmaceutical had debt of CN¥149.0m at the end of September 2023, a reduction from CN¥297.8m over a year. However, its balance sheet shows it holds CN¥501.6m in cash, so it actually has CN¥352.6m net cash.

How Strong Is Hunan Er-Kang Pharmaceutical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hunan Er-Kang Pharmaceutical had liabilities of CN¥388.4m due within 12 months and liabilities of CN¥69.2m due beyond that. Offsetting this, it had CN¥501.6m in cash and CN¥160.2m in receivables that were due within 12 months. So it can boast CN¥204.2m more liquid assets than total liabilities.

This short term liquidity is a sign that Hunan Er-Kang Pharmaceutical could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hunan Er-Kang Pharmaceutical 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 Hunan Er-Kang Pharmaceutical'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.

Over 12 months, Hunan Er-Kang Pharmaceutical saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

So How Risky Is Hunan Er-Kang Pharmaceutical?

While Hunan Er-Kang Pharmaceutical lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥50m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre 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 example Hunan Er-Kang Pharmaceutical has 3 warning signs (and 2 which can't be ignored) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.