David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Star Lake Bioscience Co., Inc.Zhaoqing Guangdong (SHSE:600866) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is Star Lake BioscienceZhaoqing Guangdong's Debt?

You can click the graphic below for the historical numbers, but it shows that Star Lake BioscienceZhaoqing Guangdong had CN¥3.81b of debt in September 2024, down from CN¥4.21b, one year before. However, it also had CN¥2.01b in cash, and so its net debt is CN¥1.80b.

How Healthy Is Star Lake BioscienceZhaoqing Guangdong's Balance Sheet?

The latest balance sheet data shows that Star Lake BioscienceZhaoqing Guangdong had liabilities of CN¥4.40b due within a year, and liabilities of CN¥2.15b falling due after that. Offsetting these obligations, it had cash of CN¥2.01b as well as receivables valued at CN¥1.39b due within 12 months. So it has liabilities totalling CN¥3.14b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Star Lake BioscienceZhaoqing Guangdong is worth CN¥10.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Star Lake BioscienceZhaoqing Guangdong's net debt is only 0.82 times its EBITDA. And its EBIT covers its interest expense a whopping 12.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Star Lake BioscienceZhaoqing Guangdong grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Star Lake BioscienceZhaoqing Guangdong can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Star Lake BioscienceZhaoqing Guangdong actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Star Lake BioscienceZhaoqing Guangdong's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Overall, we don't think Star Lake BioscienceZhaoqing Guangdong is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Star Lake BioscienceZhaoqing Guangdong has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.