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.' 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 Livzon Pharmaceutical Group Inc. (SZSE:000513) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Livzon Pharmaceutical Group Carry?

As you can see below, Livzon Pharmaceutical Group had CN¥3.56b of debt at March 2024, down from CN¥4.03b a year prior. But on the other hand it also has CN¥11.2b in cash, leading to a CN¥7.67b net cash position.

A Look At Livzon Pharmaceutical Group's Liabilities

We can see from the most recent balance sheet that Livzon Pharmaceutical Group had liabilities of CN¥8.33b falling due within a year, and liabilities of CN¥1.42b due beyond that. Offsetting this, it had CN¥11.2b in cash and CN¥3.65b in receivables that were due within 12 months. So it can boast CN¥5.13b more liquid assets than total liabilities.

This surplus suggests that Livzon Pharmaceutical Group is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Livzon Pharmaceutical Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Livzon Pharmaceutical Group grew its EBIT by 3.2% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Livzon Pharmaceutical Group'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, a company can only pay off debt with cold hard cash, not accounting profits. While Livzon Pharmaceutical Group 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. During the last three years, Livzon Pharmaceutical Group generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Livzon Pharmaceutical Group has net cash of CN¥7.67b, as well as more liquid assets than liabilities. The cherry on top was that in converted 92% of that EBIT to free cash flow, bringing in CN¥3.0b. So is Livzon Pharmaceutical Group's debt a risk? It doesn't seem so to us. 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. Be aware that Livzon Pharmaceutical Group is showing 1 warning sign 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.

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