Tonghua Dongbao Pharmaceutical (SHSE:600867) Has A Pretty Healthy Balance Sheet

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 note that Tonghua Dongbao Pharmaceutical Co., Ltd. (SHSE:600867) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, 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 Tonghua Dongbao Pharmaceutical

How Much Debt Does Tonghua Dongbao Pharmaceutical Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Tonghua Dongbao Pharmaceutical had debt of CN¥359.0m, up from CN¥70.0m in one year. However, it does have CN¥512.4m in cash offsetting this, leading to net cash of CN¥153.4m.

How Healthy Is Tonghua Dongbao Pharmaceutical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tonghua Dongbao Pharmaceutical had liabilities of CN¥406.8m due within 12 months and liabilities of CN¥141.5m due beyond that. Offsetting these obligations, it had cash of CN¥512.4m as well as receivables valued at CN¥614.8m due within 12 months. So it actually has CN¥578.9m more liquid assets than total liabilities.

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

It is just as well that Tonghua Dongbao Pharmaceutical's load is not too heavy, because its EBIT was down 23% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tonghua Dongbao Pharmaceutical 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Tonghua Dongbao 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. Looking at the most recent three years, Tonghua Dongbao Pharmaceutical recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Tonghua Dongbao Pharmaceutical has CN¥153.4m in net cash and a decent-looking balance sheet. So we are not troubled with Tonghua Dongbao Pharmaceutical's debt use. 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 Tonghua Dongbao Pharmaceutical has 3 warning signs (and 1 which is potentially serious) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.