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 Zhejiang Shouxiangu Pharmaceutical Co., Ltd. (SHSE:603896) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Shouxiangu Pharmaceutical's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zhejiang Shouxiangu Pharmaceutical had CN¥553.9m of debt in September 2024, down from CN¥668.3m, one year before. But it also has CN¥1.16b in cash to offset that, meaning it has CN¥610.1m net cash.

How Strong Is Zhejiang Shouxiangu Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Zhejiang Shouxiangu Pharmaceutical had liabilities of CN¥378.6m due within a year, and liabilities of CN¥443.9m falling due after that. Offsetting this, it had CN¥1.16b in cash and CN¥127.2m in receivables that were due within 12 months. So it can boast CN¥468.6m more liquid assets than total liabilities.

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

It is just as well that Zhejiang Shouxiangu Pharmaceutical's load is not too heavy, because its EBIT was down 33% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Zhejiang Shouxiangu 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Zhejiang Shouxiangu 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, Zhejiang Shouxiangu Pharmaceutical saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Shouxiangu Pharmaceutical has net cash of CN¥610.1m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Zhejiang Shouxiangu Pharmaceutical's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Zhejiang Shouxiangu Pharmaceutical is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.