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. As with many other companies CSPC Pharmaceutical Group Limited (HKG:1093) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for CSPC Pharmaceutical Group

What Is CSPC Pharmaceutical Group's Net Debt?

As you can see below, at the end of June 2022, CSPC Pharmaceutical Group had CN¥396.4m of debt, up from none a year ago. Click the image for more detail. However, it does have CN¥14.0b in cash offsetting this, leading to net cash of CN¥13.6b.

How Strong Is CSPC Pharmaceutical Group's Balance Sheet?

According to the last reported balance sheet, CSPC Pharmaceutical Group had liabilities of CN¥8.46b due within 12 months, and liabilities of CN¥964.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥14.0b as well as receivables valued at CN¥6.23b due within 12 months. So it actually has CN¥10.8b more liquid assets than total liabilities.

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

Also good is that CSPC Pharmaceutical Group grew its EBIT at 10% over the last year, further increasing its ability to manage debt. 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 CSPC Pharmaceutical Group 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. CSPC Pharmaceutical Group 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, CSPC Pharmaceutical Group recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that CSPC Pharmaceutical Group has net cash of CN¥13.6b, as well as more liquid assets than liabilities. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in CN¥2.9b. So is CSPC Pharmaceutical Group's debt a risk? It doesn't seem so to us. We'd be very excited to see if CSPC Pharmaceutical Group insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.