Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Guizhou Xinbang Pharmaceutical Co., Ltd. (SZSE:002390) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Guizhou Xinbang Pharmaceutical

How Much Debt Does Guizhou Xinbang Pharmaceutical Carry?

You can click the graphic below for the historical numbers, but it shows that Guizhou Xinbang Pharmaceutical had CN¥1.13b of debt in September 2023, down from CN¥1.64b, one year before. However, it does have CN¥1.06b in cash offsetting this, leading to net debt of about CN¥68.5m.

How Strong Is Guizhou Xinbang Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Guizhou Xinbang Pharmaceutical had liabilities of CN¥2.44b due within a year, and liabilities of CN¥38.2m falling due after that. Offsetting this, it had CN¥1.06b in cash and CN¥3.47b in receivables that were due within 12 months. So it can boast CN¥2.05b more liquid assets than total liabilities.

This surplus suggests that Guizhou Xinbang Pharmaceutical is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. But either way, Guizhou Xinbang Pharmaceutical has virtually no net debt, so it's fair to say it does not have a heavy debt load!

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Guizhou Xinbang Pharmaceutical has a low net debt to EBITDA ratio of only 0.11. And its EBIT covers its interest expense a whopping 17.4 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Guizhou Xinbang Pharmaceutical's EBIT dived 18%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is Guizhou Xinbang Pharmaceutical's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Guizhou Xinbang Pharmaceutical actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that Guizhou Xinbang Pharmaceutical's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its EBIT growth rate. Looking at the bigger picture, we think Guizhou Xinbang Pharmaceutical's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Guizhou Xinbang Pharmaceutical that 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.

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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.