Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Shenzhen Salubris Pharmaceuticals Co., Ltd. (SZSE:002294) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. 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 Shenzhen Salubris Pharmaceuticals's Net Debt?

As you can see below, Shenzhen Salubris Pharmaceuticals had CN¥60.0m of debt at September 2024, down from CN¥189.6m a year prior. However, it does have CN¥1.91b in cash offsetting this, leading to net cash of CN¥1.85b.

A Look At Shenzhen Salubris Pharmaceuticals' Liabilities

We can see from the most recent balance sheet that Shenzhen Salubris Pharmaceuticals had liabilities of CN¥1.01b falling due within a year, and liabilities of CN¥576.9m due beyond that. Offsetting this, it had CN¥1.91b in cash and CN¥629.9m in receivables that were due within 12 months. So it actually has CN¥951.8m more liquid assets than total liabilities.

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

The good news is that Shenzhen Salubris Pharmaceuticals has increased its EBIT by 2.6% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shenzhen Salubris Pharmaceuticals'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. While Shenzhen Salubris Pharmaceuticals 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 most recent three years, Shenzhen Salubris Pharmaceuticals recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen Salubris Pharmaceuticals has CN¥1.85b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in CN¥561m. So we don't think Shenzhen Salubris Pharmaceuticals's use of debt is risky. 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. For example, we've discovered 2 warning signs for Shenzhen Salubris Pharmaceuticals (1 doesn't sit too well with us!) 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.