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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Hubei Jumpcan Pharmaceutical Co., Ltd. (SHSE:600566) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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 Hubei Jumpcan Pharmaceutical's Debt?

As you can see below, at the end of March 2024, Hubei Jumpcan Pharmaceutical had CN¥1.69b of debt, up from CN¥400.0m a year ago. Click the image for more detail. But on the other hand it also has CN¥12.8b in cash, leading to a CN¥11.1b net cash position.

A Look At Hubei Jumpcan Pharmaceutical's Liabilities

We can see from the most recent balance sheet that Hubei Jumpcan Pharmaceutical had liabilities of CN¥4.96b falling due within a year, and liabilities of CN¥184.2m due beyond that. Offsetting these obligations, it had cash of CN¥12.8b as well as receivables valued at CN¥2.04b due within 12 months. So it can boast CN¥9.73b more liquid assets than total liabilities.

This excess liquidity is a great indication that Hubei Jumpcan Pharmaceutical's balance sheet is almost as strong as Fort Knox. 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 Hubei Jumpcan Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

Also positive, Hubei Jumpcan Pharmaceutical grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hubei Jumpcan Pharmaceutical can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Hubei Jumpcan Pharmaceutical 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. Happily for any shareholders, Hubei Jumpcan Pharmaceutical actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hubei Jumpcan Pharmaceutical has CN¥11.1b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 110% of that EBIT to free cash flow, bringing in CN¥3.2b. When it comes to Hubei Jumpcan Pharmaceutical's debt, we sufficiently relaxed that our mind turns to the jacuzzi. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Hubei Jumpcan Pharmaceutical has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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