Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Hunan Jiudian Pharmaceutical Co., Ltd. (SZSE:300705) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Hunan Jiudian Pharmaceutical's Debt?

As you can see below, at the end of March 2024, Hunan Jiudian Pharmaceutical had CN¥393.1m of debt, up from CN¥367.1m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥655.4m in cash, so it actually has CN¥262.3m net cash.

A Look At Hunan Jiudian Pharmaceutical's Liabilities

Zooming in on the latest balance sheet data, we can see that Hunan Jiudian Pharmaceutical had liabilities of CN¥357.3m due within 12 months and liabilities of CN¥494.1m due beyond that. Offsetting these obligations, it had cash of CN¥655.4m as well as receivables valued at CN¥502.2m due within 12 months. So it can boast CN¥306.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Hunan Jiudian Pharmaceutical could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Hunan Jiudian Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Hunan Jiudian Pharmaceutical grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hunan Jiudian Pharmaceutical 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hunan Jiudian 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. Over the last three years, Hunan Jiudian Pharmaceutical reported free cash flow worth 8.8% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hunan Jiudian Pharmaceutical has net cash of CN¥262.3m, as well as more liquid assets than liabilities. And we liked the look of last year's 64% year-on-year EBIT growth. So we don't think Hunan Jiudian Pharmaceutical's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Hunan Jiudian Pharmaceutical, you may well want to click here to check an interactive graph of its earnings per share history.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.