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. We note that Chengdu Easton Biopharmaceuticals Co., Ltd. (SHSE:688513) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Chengdu Easton Biopharmaceuticals's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Chengdu Easton Biopharmaceuticals had CN¥200.7m of debt, an increase on CN¥124.6m, over one year. But on the other hand it also has CN¥1.49b in cash, leading to a CN¥1.29b net cash position.

How Strong Is Chengdu Easton Biopharmaceuticals' Balance Sheet?

We can see from the most recent balance sheet that Chengdu Easton Biopharmaceuticals had liabilities of CN¥666.7m falling due within a year, and liabilities of CN¥81.6m due beyond that. Offsetting these obligations, it had cash of CN¥1.49b as well as receivables valued at CN¥216.7m due within 12 months. So it can boast CN¥956.1m more liquid assets than total liabilities.

This surplus suggests that Chengdu Easton Biopharmaceuticals is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Chengdu Easton Biopharmaceuticals boasts net cash, so it's fair to say it does not have a heavy debt load!

Chengdu Easton Biopharmaceuticals's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Chengdu Easton Biopharmaceuticals can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Chengdu Easton Biopharmaceuticals has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Chengdu Easton Biopharmaceuticals saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Chengdu Easton Biopharmaceuticals has net cash of CN¥1.29b, as well as more liquid assets than liabilities. So we are not troubled with Chengdu Easton Biopharmaceuticals's debt use. 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 instance, we've identified 2 warning signs for Chengdu Easton Biopharmaceuticals that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com