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.' 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 Cisen Pharmaceutical Co., Ltd. (SHSE:603367) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Cisen Pharmaceutical's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Cisen Pharmaceutical had debt of CN¥194.8m, up from CN¥152.5m in one year. But it also has CN¥2.79b in cash to offset that, meaning it has CN¥2.60b net cash.

A Look At Cisen Pharmaceutical's Liabilities

According to the last reported balance sheet, Cisen Pharmaceutical had liabilities of CN¥1.43b due within 12 months, and liabilities of CN¥191.8m due beyond 12 months. On the other hand, it had cash of CN¥2.79b and CN¥1.39b worth of receivables due within a year. So it can boast CN¥2.56b more liquid assets than total liabilities.

This luscious liquidity implies that Cisen Pharmaceutical's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Cisen Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Cisen Pharmaceutical has boosted its EBIT by 50%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Cisen Pharmaceutical will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Cisen Pharmaceutical may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Cisen Pharmaceutical recorded free cash flow worth a fulsome 100% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Cisen Pharmaceutical has net cash of CN¥2.60b, as well as more liquid assets than liabilities. The cherry on top was that in converted 100% of that EBIT to free cash flow, bringing in CN¥557m. The bottom line is that we do not find Cisen Pharmaceutical's debt levels at all concerning. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Cisen Pharmaceutical (1 is significant!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.