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.' 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 note that Zhejiang Wolwo Bio-Pharmaceutical Co., Ltd. (SZSE:300357) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Zhejiang Wolwo Bio-Pharmaceutical

What Is Zhejiang Wolwo Bio-Pharmaceutical's Net Debt?

As you can see below, at the end of September 2023, Zhejiang Wolwo Bio-Pharmaceutical had CN¥14.7m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.18b in cash, so it actually has CN¥1.17b net cash.

A Look At Zhejiang Wolwo Bio-Pharmaceutical's Liabilities

We can see from the most recent balance sheet that Zhejiang Wolwo Bio-Pharmaceutical had liabilities of CN¥168.0m falling due within a year, and liabilities of CN¥74.7m due beyond that. Offsetting this, it had CN¥1.18b in cash and CN¥297.7m in receivables that were due within 12 months. So it actually has CN¥1.24b more liquid assets than total liabilities.

This short term liquidity is a sign that Zhejiang Wolwo Bio-Pharmaceutical could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Zhejiang Wolwo Bio-Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Zhejiang Wolwo Bio-Pharmaceutical's saving grace is its low debt levels, because its EBIT has tanked 35% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zhejiang Wolwo Bio-Pharmaceutical 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Zhejiang Wolwo Bio-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. Over the most recent three years, Zhejiang Wolwo Bio-Pharmaceutical recorded free cash flow worth 51% 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 it is always sensible to investigate a company's debt, in this case Zhejiang Wolwo Bio-Pharmaceutical has CN¥1.17b in net cash and a decent-looking balance sheet. So we are not troubled with Zhejiang Wolwo Bio-Pharmaceutical's debt use. 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. Case in point: We've spotted 1 warning sign for Zhejiang Wolwo Bio-Pharmaceutical 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.

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.