David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Shanghai Henlius Biotech, Inc. (HKG:2696) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shanghai Henlius Biotech

How Much Debt Does Shanghai Henlius Biotech Carry?

The image below, which you can click on for greater detail, shows that at June 2022 Shanghai Henlius Biotech had debt of CN¥3.27b, up from CN¥2.30b in one year. However, it does have CN¥794.7m in cash offsetting this, leading to net debt of about CN¥2.48b.

How Healthy Is Shanghai Henlius Biotech's Balance Sheet?

We can see from the most recent balance sheet that Shanghai Henlius Biotech had liabilities of CN¥4.23b falling due within a year, and liabilities of CN¥1.88b due beyond that. Offsetting these obligations, it had cash of CN¥794.7m as well as receivables valued at CN¥554.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.76b.

This is a mountain of leverage relative to its market capitalization of CN¥6.79b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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 Shanghai Henlius Biotech 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.

Over 12 months, Shanghai Henlius Biotech reported revenue of CN¥2.3b, which is a gain of 111%, although it did not report any earnings before interest and tax. So its pretty obvious shareholders are hoping for more growth!

Caveat Emptor

Despite the top line growth, Shanghai Henlius Biotech still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥401m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥1.0b of cash over the last year. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Shanghai Henlius Biotech .

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.