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 Pacific Shuanglin Bio-pharmacy Co., LTD (SZSE:000403) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Pacific Shuanglin Bio-pharmacy's Debt?

As you can see below, at the end of June 2024, Pacific Shuanglin Bio-pharmacy had CN¥505.7m of debt, up from CN¥438.1m a year ago. Click the image for more detail. However, it does have CN¥1.70b in cash offsetting this, leading to net cash of CN¥1.20b.

How Strong Is Pacific Shuanglin Bio-pharmacy's Balance Sheet?

We can see from the most recent balance sheet that Pacific Shuanglin Bio-pharmacy had liabilities of CN¥920.2m falling due within a year, and liabilities of CN¥307.4m due beyond that. Offsetting this, it had CN¥1.70b in cash and CN¥547.3m in receivables that were due within 12 months. So it can boast CN¥1.02b more liquid assets than total liabilities.

This surplus suggests that Pacific Shuanglin Bio-pharmacy has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Pacific Shuanglin Bio-pharmacy boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Pacific Shuanglin Bio-pharmacy grew its EBIT by 75% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Pacific Shuanglin Bio-pharmacy can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Pacific Shuanglin Bio-pharmacy 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. In the last three years, Pacific Shuanglin Bio-pharmacy's free cash flow amounted to 30% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Pacific Shuanglin Bio-pharmacy has net cash of CN¥1.20b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 75% over the last year. So is Pacific Shuanglin Bio-pharmacy's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 1 warning sign for Pacific Shuanglin Bio-pharmacy that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.