Here's Why Guizhou Xinbang Pharmaceutical (SZSE:002390) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that Guizhou Xinbang Pharmaceutical Co., Ltd. (SZSE:002390) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Guizhou Xinbang Pharmaceutical

What Is Guizhou Xinbang Pharmaceutical's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Guizhou Xinbang Pharmaceutical had CN¥609.3m of debt in September 2024, down from CN¥1.13b, one year before. However, its balance sheet shows it holds CN¥752.3m in cash, so it actually has CN¥143.1m net cash.

How Healthy Is Guizhou Xinbang Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Guizhou Xinbang Pharmaceutical had liabilities of CN¥1.76b due within a year, and liabilities of CN¥40.8m falling due after that. Offsetting these obligations, it had cash of CN¥752.3m as well as receivables valued at CN¥3.20b due within 12 months. So it can boast CN¥2.15b more liquid assets than total liabilities.

This excess liquidity suggests that Guizhou Xinbang Pharmaceutical is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Guizhou Xinbang Pharmaceutical boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Guizhou Xinbang Pharmaceutical's load is not too heavy, because its EBIT was down 23% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Guizhou Xinbang Pharmaceutical's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Guizhou Xinbang Pharmaceutical has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Guizhou Xinbang Pharmaceutical actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guizhou Xinbang Pharmaceutical has net cash of CN¥143.1m, as well as more liquid assets than liabilities. The cherry on top was that in converted 133% of that EBIT to free cash flow, bringing in CN¥343m. So is Guizhou Xinbang Pharmaceutical's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Guizhou Xinbang Pharmaceutical you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.