The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, 3SBio Inc. (HKG:1530) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is 3SBio's Debt?

As you can see below, 3SBio had CN¥4.17b of debt at June 2024, down from CN¥4.94b a year prior. However, it does have CN¥5.78b in cash offsetting this, leading to net cash of CN¥1.61b.

A Look At 3SBio's Liabilities

According to the last reported balance sheet, 3SBio had liabilities of CN¥5.35b due within 12 months, and liabilities of CN¥1.72b due beyond 12 months. Offsetting this, it had CN¥5.78b in cash and CN¥1.25b in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to 3SBio's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥12.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, 3SBio boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, 3SBio saw its EBIT drop by 9.4% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine 3SBio'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 3SBio 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. During the last three years, 3SBio produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about 3SBio's liabilities, but we can be reassured by the fact it has has net cash of CN¥1.61b. So we are not troubled with 3SBio's debt use. 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. To that end, you should be aware of the 1 warning sign we've spotted with 3SBio .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.