Here's Why China National Accord Medicines (SZSE:000028) Can Manage Its Debt Responsibly

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 China National Accord Medicines Corporation Ltd. (SZSE:000028) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China National Accord Medicines

What Is China National Accord Medicines's Debt?

The image below, which you can click on for greater detail, shows that China National Accord Medicines had debt of CN¥4.30b at the end of September 2024, a reduction from CN¥5.39b over a year. However, its balance sheet shows it holds CN¥5.43b in cash, so it actually has CN¥1.13b net cash.

A Look At China National Accord Medicines' Liabilities

The latest balance sheet data shows that China National Accord Medicines had liabilities of CN¥28.1b due within a year, and liabilities of CN¥2.23b falling due after that. Offsetting this, it had CN¥5.43b in cash and CN¥26.1b in receivables that were due within 12 months. So it actually has CN¥1.18b 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. Simply put, the fact that China National Accord Medicines has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, China National Accord Medicines's EBIT dived 20%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. 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'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. 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. Over the last three years, China National Accord Medicines recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

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¥1.13b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.5b, being 94% of its EBIT. So we don't think China National Accord Medicines's use of debt is risky. 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.