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 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. Importantly, Zhangzhou Pientzehuang Pharmaceutical., Ltd (SHSE:600436) does carry debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Zhangzhou Pientzehuang Pharmaceutical Carry?

As you can see below, at the end of September 2024, Zhangzhou Pientzehuang Pharmaceutical had CN¥1.06b of debt, up from CN¥843.4m a year ago. Click the image for more detail. However, it does have CN¥3.27b in cash offsetting this, leading to net cash of CN¥2.21b.

How Strong Is Zhangzhou Pientzehuang Pharmaceutical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zhangzhou Pientzehuang Pharmaceutical had liabilities of CN¥3.10b due within 12 months and liabilities of CN¥289.5m due beyond that. On the other hand, it had cash of CN¥3.27b and CN¥936.3m worth of receivables due within a year. So it actually has CN¥820.1m more liquid assets than total liabilities.

This state of affairs indicates that Zhangzhou Pientzehuang Pharmaceutical's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥134.8b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Zhangzhou Pientzehuang Pharmaceutical boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Zhangzhou Pientzehuang Pharmaceutical grew its EBIT by 7.2% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhangzhou Pientzehuang Pharmaceutical's ability to maintain a healthy balance sheet going forward. 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. Zhangzhou Pientzehuang Pharmaceutical 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. Over the last three years, Zhangzhou Pientzehuang Pharmaceutical actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhangzhou Pientzehuang Pharmaceutical has net cash of CN¥2.21b, as well as more liquid assets than liabilities. The cherry on top was that in converted 102% of that EBIT to free cash flow, bringing in CN¥1.0b. So we don't think Zhangzhou Pientzehuang Pharmaceutical'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. For example, we've discovered 1 warning sign for Zhangzhou Pientzehuang Pharmaceutical that you should be aware of before investing here.

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.