Zhejiang Shouxiangu Pharmaceutical (SHSE:603896) Takes On Some Risk With Its Use Of Debt

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.' 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. Importantly, Zhejiang Shouxiangu Pharmaceutical Co., Ltd. (SHSE:603896) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Zhejiang Shouxiangu Pharmaceutical

How Much Debt Does Zhejiang Shouxiangu Pharmaceutical Carry?

As you can see below, Zhejiang Shouxiangu Pharmaceutical had CN¥553.9m of debt at September 2024, down from CN¥668.3m a year prior. However, its balance sheet shows it holds CN¥1.16b in cash, so it actually has CN¥610.1m net cash.

How Strong Is Zhejiang Shouxiangu Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Zhejiang Shouxiangu Pharmaceutical had liabilities of CN¥378.6m due within a year, and liabilities of CN¥443.9m falling due after that. On the other hand, it had cash of CN¥1.16b and CN¥127.2m worth of receivables due within a year. So it can boast CN¥468.6m more liquid assets than total liabilities.

This surplus suggests that Zhejiang Shouxiangu Pharmaceutical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Zhejiang Shouxiangu Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Zhejiang Shouxiangu Pharmaceutical's load is not too heavy, because its EBIT was down 33% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Zhejiang Shouxiangu Pharmaceutical's ability to maintain a healthy balance sheet going forward. 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. Zhejiang Shouxiangu Pharmaceutical 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, Zhejiang Shouxiangu Pharmaceutical saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Shouxiangu Pharmaceutical has net cash of CN¥610.1m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Zhejiang Shouxiangu Pharmaceutical's balance sheet. 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. Case in point: We've spotted 2 warning signs for Zhejiang Shouxiangu Pharmaceutical you should be aware of, and 1 of them can't be ignored.

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.