China National Accord Medicines (SZSE:000028) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies China National Accord Medicines Corporation Ltd. (SZSE:000028) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China National Accord Medicines

What Is China National Accord Medicines's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 China National Accord Medicines had debt of CN¥5.08b, up from CN¥4.75b in one year. However, it does have CN¥6.01b in cash offsetting this, leading to net cash of CN¥926.8m.

How Healthy Is China National Accord Medicines' Balance Sheet?

According to the last reported balance sheet, China National Accord Medicines had liabilities of CN¥27.7b due within 12 months, and liabilities of CN¥2.38b due beyond 12 months. Offsetting these obligations, it had cash of CN¥6.01b as well as receivables valued at CN¥24.8b due within 12 months. So it can boast CN¥766.2m more liquid assets than total liabilities.

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

On the other hand, China National Accord Medicines's EBIT dived 16%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 China National Accord Medicines can strengthen its balance sheet over time. 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. China National Accord Medicines 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. During the last three years, China National Accord Medicines generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that China National Accord Medicines has net cash of CN¥926.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in CN¥2.1b. So is China National Accord Medicines's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for China National Accord Medicines that you should be aware of before investing here.

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.