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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Northeast Pharmaceutical Group Co., Ltd. (SZSE:000597) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

What Is Northeast Pharmaceutical Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Northeast Pharmaceutical Group had CN¥2.12b of debt in September 2024, down from CN¥2.53b, one year before. But it also has CN¥5.08b in cash to offset that, meaning it has CN¥2.95b net cash.

How Healthy Is Northeast Pharmaceutical Group's Balance Sheet?

The latest balance sheet data shows that Northeast Pharmaceutical Group had liabilities of CN¥8.79b due within a year, and liabilities of CN¥350.8m falling due after that. Offsetting these obligations, it had cash of CN¥5.08b as well as receivables valued at CN¥2.93b due within 12 months. So its liabilities total CN¥1.14b more than the combination of its cash and short-term receivables.

Given Northeast Pharmaceutical Group has a market capitalization of CN¥7.26b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Northeast Pharmaceutical Group boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Northeast Pharmaceutical Group grew its EBIT by 11% 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 you can't view debt in total isolation; since Northeast Pharmaceutical Group will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Northeast 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 last three years, Northeast Pharmaceutical Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Northeast Pharmaceutical Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥2.95b. And it impressed us with free cash flow of CN¥494m, being 192% of its EBIT. So we don't think Northeast Pharmaceutical Group's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for Northeast Pharmaceutical Group you should be aware of.

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.