Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 KPC Pharmaceuticals,Inc. (SHSE:600422) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is KPC PharmaceuticalsInc's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 KPC PharmaceuticalsInc had CN¥855.0m of debt, an increase on CN¥816.2m, over one year. However, its balance sheet shows it holds CN¥1.96b in cash, so it actually has CN¥1.11b net cash.

How Strong Is KPC PharmaceuticalsInc's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that KPC PharmaceuticalsInc had liabilities of CN¥3.80b due within 12 months and liabilities of CN¥429.1m due beyond that. Offsetting these obligations, it had cash of CN¥1.96b as well as receivables valued at CN¥3.36b due within 12 months. So it actually has CN¥1.10b more liquid assets than total liabilities.

This surplus suggests that KPC PharmaceuticalsInc has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that KPC PharmaceuticalsInc has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that KPC PharmaceuticalsInc has seen its EBIT plunge 15% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if KPC PharmaceuticalsInc 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. KPC PharmaceuticalsInc 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. Looking at the most recent three years, KPC PharmaceuticalsInc recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that KPC PharmaceuticalsInc has net cash of CN¥1.11b, as well as more liquid assets than liabilities. So we are not troubled with KPC PharmaceuticalsInc's debt use. 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 - KPC PharmaceuticalsInc has 1 warning sign we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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