Here's Why Zhejiang Medicine (SHSE:600216) Can Manage Its Debt Responsibly

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.' 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. Importantly, Zhejiang Medicine Co., Ltd. (SHSE:600216) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Zhejiang Medicine

How Much Debt Does Zhejiang Medicine Carry?

As you can see below, Zhejiang Medicine had CN¥749.2m of debt at September 2024, down from CN¥801.0m a year prior. But on the other hand it also has CN¥1.96b in cash, leading to a CN¥1.21b net cash position.

A Look At Zhejiang Medicine's Liabilities

According to the last reported balance sheet, Zhejiang Medicine had liabilities of CN¥2.36b due within 12 months, and liabilities of CN¥462.0m due beyond 12 months. On the other hand, it had cash of CN¥1.96b and CN¥2.04b worth of receivables due within a year. So it actually has CN¥1.18b more liquid assets than total liabilities.

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

Better yet, Zhejiang Medicine grew its EBIT by 187% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhejiang Medicine 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. Zhejiang Medicine 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 Medicine reported free cash flow worth 2.3% 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 it is always sensible to investigate a company's debt, in this case Zhejiang Medicine has CN¥1.21b in net cash and a decent-looking balance sheet. And we liked the look of last year's 187% year-on-year EBIT growth. So is Zhejiang Medicine's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Zhejiang Medicine 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.