Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Porton Pharma Solutions Ltd. (SZSE:300363) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Porton Pharma Solutions

What Is Porton Pharma Solutions's Debt?

As you can see below, at the end of June 2022, Porton Pharma Solutions had CN¥875.3m of debt, up from CN¥319.9m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.40b in cash, leading to a CN¥527.5m net cash position.

A Look At Porton Pharma Solutions' Liabilities

Zooming in on the latest balance sheet data, we can see that Porton Pharma Solutions had liabilities of CN¥3.28b due within 12 months and liabilities of CN¥952.6m due beyond that. On the other hand, it had cash of CN¥1.40b and CN¥2.85b worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

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¥33.2b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Porton Pharma Solutions has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Porton Pharma Solutions grew its EBIT by 267% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Porton Pharma Solutions'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. 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. Considering the last three years, Porton Pharma Solutions actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case Porton Pharma Solutions has CN¥527.5m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 267% over the last year. So we don't have any problem with Porton Pharma Solutions's use of debt. 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. For example - Porton Pharma Solutions has 1 warning sign we think you should be aware of.

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.