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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Jiangsu Nhwa Pharmaceutical Co., LTD (SZSE:002262) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Jiangsu Nhwa Pharmaceutical

What Is Jiangsu Nhwa Pharmaceutical's Net Debt?

The chart below, which you can click on for greater detail, shows that Jiangsu Nhwa Pharmaceutical had CN¥30.2m in debt in September 2023; about the same as the year before. However, its balance sheet shows it holds CN¥3.39b in cash, so it actually has CN¥3.36b net cash.

How Strong Is Jiangsu Nhwa Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Jiangsu Nhwa Pharmaceutical had liabilities of CN¥792.3m due within a year, and liabilities of CN¥80.2m falling due after that. On the other hand, it had cash of CN¥3.39b and CN¥1.03b worth of receivables due within a year. So it can boast CN¥3.55b more liquid assets than total liabilities.

This short term liquidity is a sign that Jiangsu Nhwa Pharmaceutical could probably pay off its debt with ease, as its balance sheet is far from stretched. 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.

Also good is that Jiangsu Nhwa Pharmaceutical grew its EBIT at 18% 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 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. During the last three years, Jiangsu Nhwa Pharmaceutical produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. 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 Jiangsu Nhwa Pharmaceutical has CN¥3.36b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in CN¥719m. So we don't think Jiangsu Nhwa Pharmaceutical's use of debt is risky. 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.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.