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 Zhejiang Wolwo Bio-Pharmaceutical Co., Ltd. (SZSE:300357) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Zhejiang Wolwo Bio-Pharmaceutical's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Zhejiang Wolwo Bio-Pharmaceutical had debt of CN¥14.7m, up from none in one year. But on the other hand it also has CN¥1.18b in cash, leading to a CN¥1.17b net cash position.
A Look At Zhejiang Wolwo Bio-Pharmaceutical's Liabilities
The latest balance sheet data shows that Zhejiang Wolwo Bio-Pharmaceutical had liabilities of CN¥168.0m due within a year, and liabilities of CN¥74.7m falling due after that. Offsetting this, it had CN¥1.18b in cash and CN¥297.7m in receivables that were due within 12 months. So it can boast CN¥1.24b more liquid assets than total liabilities.
This surplus suggests that Zhejiang Wolwo Bio-Pharmaceutical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Zhejiang Wolwo Bio-Pharmaceutical boasts net cash, so it's fair to say it does not have a heavy debt load!
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 it is future earnings, more than anything, that will determine Zhejiang Wolwo Bio-Pharmaceutical's ability to maintain a healthy balance sheet going forward. 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. During the last three years, Zhejiang Wolwo Bio-Pharmaceutical produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Wolwo Bio-Pharmaceutical has net cash of CN¥1.17b, as well as more liquid assets than liabilities. So we don't have any problem with Zhejiang Wolwo Bio-Pharmaceutical's use of debt. 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. For example, we've discovered 1 warning sign for Zhejiang Wolwo Bio-Pharmaceutical that you should be aware of before investing here.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.