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. As with many other companies Hebei Changshan Biochemical Pharmaceutical Co., Ltd. (SZSE:300255) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Hebei Changshan Biochemical Pharmaceutical Carry?

You can click the graphic below for the historical numbers, but it shows that Hebei Changshan Biochemical Pharmaceutical had CN¥2.28b of debt in June 2024, down from CN¥2.64b, one year before. On the flip side, it has CN¥338.8m in cash leading to net debt of about CN¥1.94b.

How Healthy Is Hebei Changshan Biochemical Pharmaceutical's Balance Sheet?

We can see from the most recent balance sheet that Hebei Changshan Biochemical Pharmaceutical had liabilities of CN¥2.33b falling due within a year, and liabilities of CN¥688.9m due beyond that. On the other hand, it had cash of CN¥338.8m and CN¥404.1m worth of receivables due within a year. So its liabilities total CN¥2.28b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Hebei Changshan Biochemical Pharmaceutical has a market capitalization of CN¥9.16b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hebei Changshan Biochemical Pharmaceutical will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Hebei Changshan Biochemical Pharmaceutical had a loss before interest and tax, and actually shrunk its revenue by 42%, to CN¥1.2b. That makes us nervous, to say the least.

Caveat Emptor

While Hebei Changshan Biochemical Pharmaceutical's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CN¥1.0b. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of CN¥1.1b into a profit. So to be blunt we do think it is risky. 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. Be aware that Hebei Changshan Biochemical Pharmaceutical 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.