Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Yifeng Pharmacy Chain Co., Ltd. (SHSE:603939) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is Yifeng Pharmacy Chain's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Yifeng Pharmacy Chain had CN¥1.80b of debt, an increase on CN¥320.5m, over one year. However, it does have CN¥7.34b in cash offsetting this, leading to net cash of CN¥5.53b.

How Strong Is Yifeng Pharmacy Chain's Balance Sheet?

The latest balance sheet data shows that Yifeng Pharmacy Chain had liabilities of CN¥11.4b due within a year, and liabilities of CN¥4.12b falling due after that. Offsetting this, it had CN¥7.34b in cash and CN¥2.39b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.80b.

Yifeng Pharmacy Chain has a market capitalization of CN¥27.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Yifeng Pharmacy Chain also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Yifeng Pharmacy Chain 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 Yifeng Pharmacy Chain'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Yifeng Pharmacy Chain 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. Happily for any shareholders, Yifeng Pharmacy Chain actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

Although Yifeng Pharmacy Chain's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥5.53b. And it impressed us with free cash flow of CN¥4.3b, being 168% of its EBIT. So is Yifeng Pharmacy Chain's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Yifeng Pharmacy Chain , 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.