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. As with many other companies Zhejiang Xianju Pharmaceutical Co.,Ltd. (SZSE:002332) makes use of debt. 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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Zhejiang Xianju PharmaceuticalLtd's Net Debt?

As you can see below, Zhejiang Xianju PharmaceuticalLtd had CN¥101.2m of debt at September 2024, down from CN¥261.2m a year prior. But on the other hand it also has CN¥1.30b in cash, leading to a CN¥1.20b net cash position.

How Strong Is Zhejiang Xianju PharmaceuticalLtd's Balance Sheet?

The latest balance sheet data shows that Zhejiang Xianju PharmaceuticalLtd had liabilities of CN¥737.7m due within a year, and liabilities of CN¥101.4m falling due after that. Offsetting this, it had CN¥1.30b in cash and CN¥927.9m in receivables that were due within 12 months. So it can boast CN¥1.39b more liquid assets than total liabilities.

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

And we also note warmly that Zhejiang Xianju PharmaceuticalLtd grew its EBIT by 12% last year, making its debt load easier to handle. 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 Zhejiang Xianju PharmaceuticalLtd 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Zhejiang Xianju PharmaceuticalLtd 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. In the last three years, Zhejiang Xianju PharmaceuticalLtd's free cash flow amounted to 40% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Xianju PharmaceuticalLtd has CN¥1.20b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 12% over the last year. So is Zhejiang Xianju PharmaceuticalLtd's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Zhejiang Xianju PharmaceuticalLtd you should be aware of.

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.