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.' 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, Changzhou Qianhong Biopharma CO.,LTD (SZSE:002550) does carry 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Changzhou Qianhong BiopharmaLTD's Net Debt?

The image below, which you can click on for greater detail, shows that Changzhou Qianhong BiopharmaLTD had debt of CN¥56.2m at the end of March 2024, a reduction from CN¥300.8m over a year. But on the other hand it also has CN¥736.8m in cash, leading to a CN¥680.6m net cash position.

How Strong Is Changzhou Qianhong BiopharmaLTD's Balance Sheet?

According to the last reported balance sheet, Changzhou Qianhong BiopharmaLTD had liabilities of CN¥208.3m due within 12 months, and liabilities of CN¥87.3m due beyond 12 months. On the other hand, it had cash of CN¥736.8m and CN¥334.1m worth of receivables due within a year. So it can boast CN¥775.3m more liquid assets than total liabilities.

This surplus suggests that Changzhou Qianhong BiopharmaLTD has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Changzhou Qianhong BiopharmaLTD boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Changzhou Qianhong BiopharmaLTD's saving grace is its low debt levels, because its EBIT has tanked 32% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Changzhou Qianhong BiopharmaLTD 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Changzhou Qianhong BiopharmaLTD 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, Changzhou Qianhong BiopharmaLTD actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Changzhou Qianhong BiopharmaLTD has net cash of CN¥680.6m, as well as more liquid assets than liabilities. The cherry on top was that in converted 101% of that EBIT to free cash flow, bringing in CN¥638m. So we are not troubled with Changzhou Qianhong BiopharmaLTD's debt use. 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. We've identified 2 warning signs with Changzhou Qianhong BiopharmaLTD , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

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