Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, PharmaBlock Sciences (Nanjing), Inc. (SZSE:300725) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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, 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 PharmaBlock Sciences (Nanjing)'s Net Debt?

You can click the graphic below for the historical numbers, but it shows that PharmaBlock Sciences (Nanjing) had CN¥1.58b of debt in March 2024, down from CN¥1.75b, one year before. However, it does have CN¥660.6m in cash offsetting this, leading to net debt of about CN¥917.2m.

How Strong Is PharmaBlock Sciences (Nanjing)'s Balance Sheet?

The latest balance sheet data shows that PharmaBlock Sciences (Nanjing) had liabilities of CN¥868.8m due within a year, and liabilities of CN¥1.22b falling due after that. On the other hand, it had cash of CN¥660.6m and CN¥457.1m worth of receivables due within a year. So its liabilities total CN¥969.3m more than the combination of its cash and short-term receivables.

Given PharmaBlock Sciences (Nanjing) has a market capitalization of CN¥5.82b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

PharmaBlock Sciences (Nanjing)'s net debt is sitting at a very reasonable 2.4 times its EBITDA, while its EBIT covered its interest expense just 5.5 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. We saw PharmaBlock Sciences (Nanjing) grow its EBIT by 2.5% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PharmaBlock Sciences (Nanjing)'s ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, PharmaBlock Sciences (Nanjing) burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

PharmaBlock Sciences (Nanjing)'s conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to to handle its total liabilities isn't too shabby at all. Taking the abovementioned factors together we do think PharmaBlock Sciences (Nanjing)'s debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. Be aware that PharmaBlock Sciences (Nanjing) is showing 2 warning signs in our investment analysis , you should know about...

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.

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