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.' 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. We can see that Xiangxue Pharmaceutical Co.,Ltd. (SZSE:300147) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Xiangxue PharmaceuticalLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Xiangxue PharmaceuticalLtd had CN¥2.31b of debt in June 2024, down from CN¥2.44b, one year before. However, it also had CN¥102.3m in cash, and so its net debt is CN¥2.20b.

How Strong Is Xiangxue PharmaceuticalLtd's Balance Sheet?

According to the last reported balance sheet, Xiangxue PharmaceuticalLtd had liabilities of CN¥5.22b due within 12 months, and liabilities of CN¥699.3m due beyond 12 months. Offsetting this, it had CN¥102.3m in cash and CN¥921.7m in receivables that were due within 12 months. So its liabilities total CN¥4.90b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥5.99b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Xiangxue PharmaceuticalLtd'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, Xiangxue PharmaceuticalLtd saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that hardly impresses, its not too bad either.

Caveat Emptor

Importantly, Xiangxue PharmaceuticalLtd had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥27m. 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. For example, we would not want to see a repeat of last year's loss of CN¥458m. So we do think this stock is quite risky. 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. For example, we've discovered 2 warning signs for Xiangxue PharmaceuticalLtd that you should be aware of before investing here.

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.