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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that KPC Pharmaceuticals,Inc (SHSE:600422) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does KPC PharmaceuticalsInc Carry?

You can click the graphic below for the historical numbers, but it shows that KPC PharmaceuticalsInc had CN¥790.8m of debt in September 2023, down from CN¥1.07b, one year before. But on the other hand it also has CN¥1.61b in cash, leading to a CN¥815.8m net cash position.

How Strong Is KPC PharmaceuticalsInc's Balance Sheet?

According to the last reported balance sheet, KPC PharmaceuticalsInc had liabilities of CN¥3.45b due within 12 months, and liabilities of CN¥429.9m due beyond 12 months. Offsetting this, it had CN¥1.61b in cash and CN¥3.16b in receivables that were due within 12 months. So it can boast CN¥881.7m more liquid assets than total liabilities.

This short term liquidity is a sign that KPC PharmaceuticalsInc could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, KPC PharmaceuticalsInc boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, KPC PharmaceuticalsInc saw its EBIT drop by 6.5% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if KPC PharmaceuticalsInc can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While KPC PharmaceuticalsInc 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. In the last three years, KPC PharmaceuticalsInc's free cash flow amounted to 21% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that KPC PharmaceuticalsInc has net cash of CN¥815.8m, as well as more liquid assets than liabilities. So we don't have any problem with KPC PharmaceuticalsInc's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with KPC PharmaceuticalsInc .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.