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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Jiangsu Nhwa Pharmaceutical Co., LTD (SZSE:002262) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is Jiangsu Nhwa Pharmaceutical's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Jiangsu Nhwa Pharmaceutical had CN¥55.2m of debt, an increase on CN¥30.2m, over one year. But it also has CN¥3.49b in cash to offset that, meaning it has CN¥3.44b net cash.

How Healthy Is Jiangsu Nhwa Pharmaceutical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jiangsu Nhwa Pharmaceutical had liabilities of CN¥814.0m due within 12 months and liabilities of CN¥104.1m due beyond that. On the other hand, it had cash of CN¥3.49b and CN¥1.10b worth of receivables due within a year. So it can boast CN¥3.67b more liquid assets than total liabilities.

This surplus suggests that Jiangsu Nhwa Pharmaceutical is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Jiangsu Nhwa Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Jiangsu Nhwa Pharmaceutical grew its EBIT by 19% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Jiangsu Nhwa Pharmaceutical's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Jiangsu Nhwa Pharmaceutical 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 most recent three years, Jiangsu Nhwa Pharmaceutical recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Jiangsu Nhwa Pharmaceutical has net cash of CN¥3.44b, as well as more liquid assets than liabilities. And we liked the look of last year's 19% year-on-year EBIT growth. So is Jiangsu Nhwa Pharmaceutical's debt a risk? It doesn't seem so to us. 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 Jiangsu Nhwa Pharmaceutical's earnings per share history for free.

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.