These 4 Measures Indicate That LanZhou Foci PharmaceuticalLtd (SZSE:002644) Is Using Debt Reasonably Well

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that LanZhou Foci Pharmaceutical Co.,Ltd. (SZSE:002644) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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 LanZhou Foci PharmaceuticalLtd

What Is LanZhou Foci PharmaceuticalLtd's Debt?

The image below, which you can click on for greater detail, shows that LanZhou Foci PharmaceuticalLtd had debt of CN¥37.9m at the end of March 2024, a reduction from CN¥40.2m over a year. However, its balance sheet shows it holds CN¥365.3m in cash, so it actually has CN¥327.4m net cash.

How Strong Is LanZhou Foci PharmaceuticalLtd's Balance Sheet?

According to the last reported balance sheet, LanZhou Foci PharmaceuticalLtd had liabilities of CN¥462.4m due within 12 months, and liabilities of CN¥278.0m due beyond 12 months. On the other hand, it had cash of CN¥365.3m and CN¥475.1m worth of receivables due within a year. So it actually has CN¥100.0m more liquid assets than total liabilities.

This surplus suggests that LanZhou Foci PharmaceuticalLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, LanZhou Foci PharmaceuticalLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that LanZhou Foci PharmaceuticalLtd's load is not too heavy, because its EBIT was down 23% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since LanZhou Foci PharmaceuticalLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. LanZhou Foci 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. In the last three years, LanZhou Foci PharmaceuticalLtd created free cash flow amounting to 18% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case LanZhou Foci PharmaceuticalLtd has CN¥327.4m in net cash and a decent-looking balance sheet. So we don't have any problem with LanZhou Foci PharmaceuticalLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with LanZhou Foci PharmaceuticalLtd .

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.

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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.

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