Is Shanghai Yizhong Pharmaceutical (SHSE:688091) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Shanghai Yizhong Pharmaceutical Co., Ltd. (SHSE:688091) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shanghai Yizhong Pharmaceutical

What Is Shanghai Yizhong Pharmaceutical's Debt?

As you can see below, at the end of June 2024, Shanghai Yizhong Pharmaceutical had CN¥31.0m of debt, up from CN¥20.1m a year ago. Click the image for more detail. However, it does have CN¥733.5m in cash offsetting this, leading to net cash of CN¥702.5m.

How Strong Is Shanghai Yizhong Pharmaceutical's Balance Sheet?

According to the last reported balance sheet, Shanghai Yizhong Pharmaceutical had liabilities of CN¥71.3m due within 12 months, and liabilities of CN¥4.22m due beyond 12 months. On the other hand, it had cash of CN¥733.5m and CN¥139.0m worth of receivables due within a year. So it can boast CN¥797.0m more liquid assets than total liabilities.

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

The modesty of its debt load may become crucial for Shanghai Yizhong Pharmaceutical if management cannot prevent a repeat of the 53% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shanghai Yizhong Pharmaceutical will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Shanghai Yizhong 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, Shanghai Yizhong Pharmaceutical recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Yizhong Pharmaceutical has net cash of CN¥702.5m, as well as more liquid assets than liabilities. So we are not troubled with Shanghai Yizhong Pharmaceutical's debt use. 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. For instance, we've identified 2 warning signs for Shanghai Yizhong Pharmaceutical that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.