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. As with many other companies Yixintang Pharmaceutical Group Co., Ltd. (SZSE:002727) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Yixintang Pharmaceutical Group

How Much Debt Does Yixintang Pharmaceutical Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Yixintang Pharmaceutical Group had CN¥1.31b of debt, an increase on CN¥1.12b, over one year. But on the other hand it also has CN¥3.33b in cash, leading to a CN¥2.02b net cash position.

How Healthy Is Yixintang Pharmaceutical Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yixintang Pharmaceutical Group had liabilities of CN¥6.50b due within 12 months and liabilities of CN¥1.82b due beyond that. Offsetting these obligations, it had cash of CN¥3.33b as well as receivables valued at CN¥2.13b due within 12 months. So its liabilities total CN¥2.86b more than the combination of its cash and short-term receivables.

Of course, Yixintang Pharmaceutical Group has a market capitalization of CN¥14.4b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Yixintang Pharmaceutical Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Yixintang Pharmaceutical Group has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Yixintang Pharmaceutical Group'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Yixintang 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. Happily for any shareholders, Yixintang Pharmaceutical Group 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 Yixintang Pharmaceutical Group does have more liabilities than liquid assets, it also has net cash of CN¥2.02b. The cherry on top was that in converted 137% of that EBIT to free cash flow, bringing in CN¥2.0b. So we don't think Yixintang Pharmaceutical Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Yixintang Pharmaceutical Group , and understanding them should be part of your investment process.

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.

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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.