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.' 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 Luoxin Pharmaceuticals Group Stock Co., Ltd. (SZSE:002793) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Luoxin Pharmaceuticals Group Stock's Net Debt?

As you can see below, Luoxin Pharmaceuticals Group Stock had CN¥1.91b of debt at June 2024, down from CN¥2.29b a year prior. On the flip side, it has CN¥900.4m in cash leading to net debt of about CN¥1.01b.

How Healthy Is Luoxin Pharmaceuticals Group Stock's Balance Sheet?

The latest balance sheet data shows that Luoxin Pharmaceuticals Group Stock had liabilities of CN¥2.57b due within a year, and liabilities of CN¥330.2m falling due after that. Offsetting these obligations, it had cash of CN¥900.4m as well as receivables valued at CN¥669.1m due within 12 months. So its liabilities total CN¥1.33b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Luoxin Pharmaceuticals Group Stock has a market capitalization of CN¥4.32b, 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Luoxin Pharmaceuticals Group Stock's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Luoxin Pharmaceuticals Group Stock reported revenue of CN¥2.4b, which is a gain of 39%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Even though Luoxin Pharmaceuticals Group Stock managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost a very considerable CN¥458m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥49m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Luoxin Pharmaceuticals Group Stock you should be aware of, and 2 of them are concerning.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.