David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Hebei Changshan Biochemical Pharmaceutical Co., Ltd. (SZSE:300255) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Hebei Changshan Biochemical Pharmaceutical's Debt?

As you can see below, Hebei Changshan Biochemical Pharmaceutical had CN¥2.03b of debt at March 2024, down from CN¥2.52b a year prior. However, it also had CN¥322.0m in cash, and so its net debt is CN¥1.71b.

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

We can see from the most recent balance sheet that Hebei Changshan Biochemical Pharmaceutical had liabilities of CN¥1.94b falling due within a year, and liabilities of CN¥993.8m due beyond that. On the other hand, it had cash of CN¥322.0m and CN¥312.7m worth of receivables due within a year. So it has liabilities totalling CN¥2.30b more than its cash and near-term receivables, combined.

Hebei Changshan Biochemical Pharmaceutical has a market capitalization of CN¥9.56b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But it is Hebei Changshan Biochemical 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.

In the last year Hebei Changshan Biochemical Pharmaceutical had a loss before interest and tax, and actually shrunk its revenue by 47%, to CN¥1.2b. That makes us nervous, to say the least.

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¥540m 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. For example, we would not want to see a repeat of last year's loss of CN¥1.3b. So we do think this stock is quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Hebei Changshan Biochemical Pharmaceutical (2 are concerning!) that you should be aware of before investing here.

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.