Here's Why Changzhou Qianhong BiopharmaLTD (SZSE:002550) Can Manage Its Debt Responsibly

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.' 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, Changzhou Qianhong Biopharma CO.,LTD (SZSE:002550) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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 Changzhou Qianhong BiopharmaLTD

How Much Debt Does Changzhou Qianhong BiopharmaLTD Carry?

As you can see below, Changzhou Qianhong BiopharmaLTD had CN¥56.2m of debt at March 2024, down from CN¥300.8m a year prior. But on the other hand it also has CN¥736.8m in cash, leading to a CN¥680.6m net cash position.

How Strong Is Changzhou Qianhong BiopharmaLTD's Balance Sheet?

We can see from the most recent balance sheet that Changzhou Qianhong BiopharmaLTD had liabilities of CN¥208.3m falling due within a year, and liabilities of CN¥87.3m due beyond that. Offsetting these obligations, it had cash of CN¥736.8m as well as receivables valued at CN¥334.1m due within 12 months. So it actually has CN¥775.3m more liquid assets than total liabilities.

This surplus suggests that Changzhou Qianhong BiopharmaLTD has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Changzhou Qianhong BiopharmaLTD 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 Changzhou Qianhong BiopharmaLTD if management cannot prevent a repeat of the 32% 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Changzhou Qianhong BiopharmaLTD can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Changzhou Qianhong BiopharmaLTD 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. Happily for any shareholders, Changzhou Qianhong BiopharmaLTD actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Changzhou Qianhong BiopharmaLTD has net cash of CN¥680.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥638m, being 101% of its EBIT. So we are not troubled with Changzhou Qianhong BiopharmaLTD's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Changzhou Qianhong BiopharmaLTD you should know about.

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.

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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.