Yabao Pharmaceutical Group (SHSE:600351) Seems To Use Debt Rather Sparingly

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.' 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 Yabao Pharmaceutical Group Co., Ltd (SHSE:600351) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Yabao Pharmaceutical Group

What Is Yabao Pharmaceutical Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Yabao Pharmaceutical Group had CN¥202.2m of debt in June 2024, down from CN¥343.2m, one year before. However, its balance sheet shows it holds CN¥609.6m in cash, so it actually has CN¥407.4m net cash.

How Strong Is Yabao Pharmaceutical Group's Balance Sheet?

According to the last reported balance sheet, Yabao Pharmaceutical Group had liabilities of CN¥792.7m due within 12 months, and liabilities of CN¥72.4m due beyond 12 months. Offsetting this, it had CN¥609.6m in cash and CN¥635.0m in receivables that were due within 12 months. So it can boast CN¥379.5m more liquid assets than total liabilities.

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

And we also note warmly that Yabao Pharmaceutical Group grew its EBIT by 17% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Yabao Pharmaceutical Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Yabao Pharmaceutical Group 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, Yabao Pharmaceutical Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Yabao Pharmaceutical Group has CN¥407.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥519m, being 162% of its EBIT. So we don't think Yabao Pharmaceutical Group'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 - Yabao Pharmaceutical Group has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.