Is Guizhou Sanli PharmaceuticalLtd (SHSE:603439) A Risky Investment?

Warren Buffett famously said, '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, Guizhou Sanli Pharmaceutical Co.,Ltd (SHSE:603439) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Guizhou Sanli PharmaceuticalLtd

What Is Guizhou Sanli PharmaceuticalLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Guizhou Sanli PharmaceuticalLtd had debt of CN¥577.7m, up from CN¥205.0m in one year. However, its balance sheet shows it holds CN¥593.1m in cash, so it actually has CN¥15.4m net cash.

How Healthy Is Guizhou Sanli PharmaceuticalLtd's Balance Sheet?

According to the last reported balance sheet, Guizhou Sanli PharmaceuticalLtd had liabilities of CN¥845.7m due within 12 months, and liabilities of CN¥355.2m due beyond 12 months. On the other hand, it had cash of CN¥593.1m and CN¥734.0m worth of receivables due within a year. So it can boast CN¥126.2m more liquid assets than total liabilities.

This short term liquidity is a sign that Guizhou Sanli PharmaceuticalLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Guizhou Sanli PharmaceuticalLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Guizhou Sanli PharmaceuticalLtd grew its EBIT at 18% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Guizhou Sanli PharmaceuticalLtd 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Guizhou Sanli PharmaceuticalLtd 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 most recent three years, Guizhou Sanli PharmaceuticalLtd recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guizhou Sanli PharmaceuticalLtd has CN¥15.4m in net cash and a decent-looking balance sheet. And we liked the look of last year's 18% year-on-year EBIT growth. So we don't think Guizhou Sanli PharmaceuticalLtd's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Guizhou Sanli PharmaceuticalLtd .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.