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.' 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 Porton Pharma Solutions Ltd. (SZSE:300363) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Porton Pharma Solutions

What Is Porton Pharma Solutions's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Porton Pharma Solutions had debt of CN¥780.4m, up from CN¥349.8m in one year. However, its balance sheet shows it holds CN¥1.54b in cash, so it actually has CN¥757.6m net cash.

How Healthy Is Porton Pharma Solutions' Balance Sheet?

We can see from the most recent balance sheet that Porton Pharma Solutions had liabilities of CN¥2.28b falling due within a year, and liabilities of CN¥725.2m due beyond that. Offsetting this, it had CN¥1.54b in cash and CN¥1.36b in receivables that were due within 12 months. So it has liabilities totalling CN¥104.1m more than its cash and near-term receivables, combined.

This state of affairs indicates that Porton Pharma Solutions' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥35.9b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Porton Pharma Solutions also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Porton Pharma Solutions grew its EBIT by 132% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Porton Pharma Solutions can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Porton Pharma Solutions 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, Porton Pharma Solutions reported free cash flow worth 6.0% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

We could understand if investors are concerned about Porton Pharma Solutions's liabilities, but we can be reassured by the fact it has has net cash of CN¥757.6m. And it impressed us with its EBIT growth of 132% over the last year. So we don't think Porton Pharma Solutions's use of debt is risky. 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. We've identified 2 warning signs with Porton Pharma Solutions (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.