Does Zhende Medical (SHSE:603301) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Zhende Medical Co., Ltd. (SHSE:603301) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Zhende Medical

How Much Debt Does Zhende Medical Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Zhende Medical had debt of CN¥1.26b, up from CN¥648.6m in one year. But on the other hand it also has CN¥1.74b in cash, leading to a CN¥478.4m net cash position.

How Strong Is Zhende Medical's Balance Sheet?

We can see from the most recent balance sheet that Zhende Medical had liabilities of CN¥1.34b falling due within a year, and liabilities of CN¥959.9m due beyond that. Offsetting these obligations, it had cash of CN¥1.74b as well as receivables valued at CN¥621.5m due within 12 months. So it actually has CN¥64.7m more liquid assets than total liabilities.

Having regard to Zhende Medical'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¥5.45b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Zhende Medical has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Zhende Medical if management cannot prevent a repeat of the 35% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Zhende Medical'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 Zhende Medical 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. Considering the last three years, Zhende Medical actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhende Medical has CN¥478.4m in net cash and a decent-looking balance sheet. So while Zhende Medical does not have a great balance sheet, it's certainly not too bad. 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. Be aware that Zhende Medical is showing 3 warning signs in our investment analysis , you should know about...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.