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 Fuan Pharmaceutical (Group) Co., Ltd. (SZSE:300194) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Fuan Pharmaceutical (Group)'s Net Debt?

As you can see below, Fuan Pharmaceutical (Group) had CN¥709.9m of debt at September 2024, down from CN¥967.8m a year prior. However, its balance sheet shows it holds CN¥969.1m in cash, so it actually has CN¥259.1m net cash.

A Look At Fuan Pharmaceutical (Group)'s Liabilities

The latest balance sheet data shows that Fuan Pharmaceutical (Group) had liabilities of CN¥1.31b due within a year, and liabilities of CN¥326.9m falling due after that. Offsetting this, it had CN¥969.1m in cash and CN¥371.4m in receivables that were due within 12 months. So its liabilities total CN¥295.9m more than the combination of its cash and short-term receivables.

Given Fuan Pharmaceutical (Group) has a market capitalization of CN¥6.16b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Fuan Pharmaceutical (Group) also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Fuan Pharmaceutical (Group) has been able to increase its EBIT by 26% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is Fuan Pharmaceutical (Group)'s earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Fuan Pharmaceutical (Group) 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, Fuan Pharmaceutical (Group) recorded free cash flow worth 50% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Fuan Pharmaceutical (Group) has CN¥259.1m in net cash. And we liked the look of last year's 26% year-on-year EBIT growth. So we don't think Fuan Pharmaceutical (Group)'s use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Fuan Pharmaceutical (Group) is showing 1 warning sign in our investment analysis , you should know about...

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.