These 4 Measures Indicate That Guangdong Zhongsheng Pharmaceutical (SZSE:002317) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Guangdong Zhongsheng Pharmaceutical Co., Ltd. (SZSE:002317) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

Check out our latest analysis for Guangdong Zhongsheng Pharmaceutical

How Much Debt Does Guangdong Zhongsheng Pharmaceutical Carry?

The image below, which you can click on for greater detail, shows that Guangdong Zhongsheng Pharmaceutical had debt of CN¥429.4m at the end of March 2024, a reduction from CN¥594.3m over a year. But it also has CN¥1.64b in cash to offset that, meaning it has CN¥1.21b net cash.

How Strong Is Guangdong Zhongsheng Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Guangdong Zhongsheng Pharmaceutical had liabilities of CN¥826.0m due within a year, and liabilities of CN¥821.2m falling due after that. Offsetting these obligations, it had cash of CN¥1.64b as well as receivables valued at CN¥1.23b due within 12 months. So it can boast CN¥1.22b more liquid assets than total liabilities.

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

In fact Guangdong Zhongsheng Pharmaceutical's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Guangdong Zhongsheng Pharmaceutical's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Guangdong Zhongsheng 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. Over the last three years, Guangdong Zhongsheng Pharmaceutical recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guangdong Zhongsheng Pharmaceutical has net cash of CN¥1.21b, as well as more liquid assets than liabilities. So we are not troubled with Guangdong Zhongsheng 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. Case in point: We've spotted 3 warning signs for Guangdong Zhongsheng Pharmaceutical you should be aware of, and 1 of them is concerning.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.

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