Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Zhangzhou Pientzehuang Pharmaceutical., Ltd (SHSE:600436) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Zhangzhou Pientzehuang Pharmaceutical

How Much Debt Does Zhangzhou Pientzehuang Pharmaceutical Carry?

The image below, which you can click on for greater detail, shows that at June 2023 Zhangzhou Pientzehuang Pharmaceutical had debt of CN¥912.0m, up from CN¥794.1m in one year. However, it does have CN¥9.98b in cash offsetting this, leading to net cash of CN¥9.07b.

How Healthy Is Zhangzhou Pientzehuang Pharmaceutical's Balance Sheet?

We can see from the most recent balance sheet that Zhangzhou Pientzehuang Pharmaceutical had liabilities of CN¥2.97b falling due within a year, and liabilities of CN¥268.5m due beyond that. Offsetting these obligations, it had cash of CN¥9.98b as well as receivables valued at CN¥962.2m due within 12 months. So it actually has CN¥7.71b more liquid assets than total liabilities.

This surplus suggests that Zhangzhou Pientzehuang Pharmaceutical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Zhangzhou Pientzehuang Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Zhangzhou Pientzehuang Pharmaceutical has increased its EBIT by 4.4% over twelve months, which should ease any concerns about debt repayment. 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 Zhangzhou Pientzehuang Pharmaceutical 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Zhangzhou Pientzehuang Pharmaceutical has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Zhangzhou Pientzehuang Pharmaceutical actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhangzhou Pientzehuang Pharmaceutical has net cash of CN¥9.07b, as well as more liquid assets than liabilities. The cherry on top was that in converted 109% of that EBIT to free cash flow, bringing in CN¥2.7b. So is Zhangzhou Pientzehuang 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 Zhangzhou Pientzehuang Pharmaceutical's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.