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. We can see that 3SBio Inc. (HKG:1530) does use debt in its business. But is this debt a concern to shareholders?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for 3SBio

How Much Debt Does 3SBio Carry?

As you can see below, at the end of June 2023, 3SBio had CN¥4.94b of debt, up from CN¥3.80b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥6.67b in cash, so it actually has CN¥1.74b net cash.

A Look At 3SBio's Liabilities

According to the last reported balance sheet, 3SBio had liabilities of CN¥3.56b due within 12 months, and liabilities of CN¥3.65b due beyond 12 months. Offsetting this, it had CN¥6.67b in cash and CN¥1.34b in receivables that were due within 12 months. So it can boast CN¥805.6m more liquid assets than total liabilities.

This surplus suggests that 3SBio has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, 3SBio boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that 3SBio has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if 3SBio 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 3SBio 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. In the last three years, 3SBio's free cash flow amounted to 46% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that 3SBio has net cash of CN¥1.74b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 40% over the last year. So we don't think 3SBio's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of 3SBio's earnings per share history for free.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.