Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Guilin Sanjin Pharmaceutical Co., Ltd. (SZSE:002275) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Guilin Sanjin Pharmaceutical's Debt?

The chart below, which you can click on for greater detail, shows that Guilin Sanjin Pharmaceutical had CN¥429.7m in debt in June 2024; about the same as the year before. But on the other hand it also has CN¥1.39b in cash, leading to a CN¥963.4m net cash position.

How Strong Is Guilin Sanjin Pharmaceutical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guilin Sanjin Pharmaceutical had liabilities of CN¥644.5m due within 12 months and liabilities of CN¥230.8m due beyond that. On the other hand, it had cash of CN¥1.39b and CN¥377.8m worth of receivables due within a year. So it actually has CN¥895.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Guilin Sanjin Pharmaceutical could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Guilin Sanjin Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Guilin Sanjin Pharmaceutical has seen its EBIT plunge 13% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is Guilin Sanjin Pharmaceutical'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Guilin Sanjin 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. Over the last three years, Guilin Sanjin Pharmaceutical actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guilin Sanjin Pharmaceutical has net cash of CN¥963.4m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥499m, being 107% of its EBIT. So we don't think Guilin Sanjin Pharmaceutical's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Guilin Sanjin Pharmaceutical you should know about.

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.