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.' 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 can see that 3SBio Inc. (HKG:1530) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

What Is 3SBio's Net Debt?

As you can see below, at the end of December 2023, 3SBio had CN¥4.80b of debt, up from CN¥4.43b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥5.99b in cash, so it actually has CN¥1.19b net cash.

How Strong Is 3SBio's Balance Sheet?

We can see from the most recent balance sheet that 3SBio had liabilities of CN¥3.73b falling due within a year, and liabilities of CN¥3.38b due beyond that. Offsetting these obligations, it had cash of CN¥5.99b as well as receivables valued at CN¥1.10b due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to 3SBio's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥13.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, 3SBio boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, 3SBio grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if 3SBio 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 3SBio 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. In the last three years, 3SBio's free cash flow amounted to 28% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about 3SBio's liabilities, but we can be reassured by the fact it has has net cash of CN¥1.19b. And it impressed us with its EBIT growth of 23% over the last year. So we don't think 3SBio's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - 3SBio has 1 warning sign we think you should be aware of.

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.