Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Sihuan Pharmaceutical Holdings Group Ltd. (HKG:460) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Sihuan Pharmaceutical Holdings Group

How Much Debt Does Sihuan Pharmaceutical Holdings Group Carry?

The image below, which you can click on for greater detail, shows that at June 2022 Sihuan Pharmaceutical Holdings Group had debt of CN¥1.12b, up from CN¥811.9m in one year. However, its balance sheet shows it holds CN¥5.25b in cash, so it actually has CN¥4.13b net cash.

How Healthy Is Sihuan Pharmaceutical Holdings Group's Balance Sheet?

The latest balance sheet data shows that Sihuan Pharmaceutical Holdings Group had liabilities of CN¥3.06b due within a year, and liabilities of CN¥3.25b falling due after that. Offsetting this, it had CN¥5.25b in cash and CN¥1.29b in receivables that were due within 12 months. So it can boast CN¥226.3m more liquid assets than total liabilities.

This surplus suggests that Sihuan Pharmaceutical Holdings Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Sihuan Pharmaceutical Holdings Group has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Sihuan Pharmaceutical Holdings Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Sihuan Pharmaceutical Holdings Group had a loss before interest and tax, and actually shrunk its revenue by 14%, to CN¥2.8b. We would much prefer see growth.

So How Risky Is Sihuan Pharmaceutical Holdings Group?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Sihuan Pharmaceutical Holdings Group had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through CN¥306m of cash and made a loss of CN¥155m. With only CN¥4.13b on the balance sheet, it would appear that its going to need to raise capital again soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Sihuan Pharmaceutical Holdings Group that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.