Shandong Jincheng Pharmaceutical Group (SZSE:300233) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Shandong Jincheng Pharmaceutical Group Co., Ltd (SZSE:300233) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Shandong Jincheng Pharmaceutical Group

How Much Debt Does Shandong Jincheng Pharmaceutical Group Carry?

You can click the graphic below for the historical numbers, but it shows that Shandong Jincheng Pharmaceutical Group had CN¥662.4m of debt in September 2023, down from CN¥737.1m, one year before. But it also has CN¥1.12b in cash to offset that, meaning it has CN¥453.6m net cash.

A Look At Shandong Jincheng Pharmaceutical Group's Liabilities

According to the last reported balance sheet, Shandong Jincheng Pharmaceutical Group had liabilities of CN¥1.61b due within 12 months, and liabilities of CN¥594.3m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.12b as well as receivables valued at CN¥788.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥298.2m.

Of course, Shandong Jincheng Pharmaceutical Group has a market capitalization of CN¥5.82b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Shandong Jincheng Pharmaceutical Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Shandong Jincheng Pharmaceutical Group's saving grace is its low debt levels, because its EBIT has tanked 41% in the last twelve months. 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 you can't view debt in total isolation; since Shandong Jincheng Pharmaceutical Group 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shandong Jincheng Pharmaceutical Group 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, Shandong Jincheng Pharmaceutical Group recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about Shandong Jincheng Pharmaceutical Group's liabilities, but we can be reassured by the fact it has has net cash of CN¥453.6m. So we are not troubled with Shandong Jincheng Pharmaceutical Group'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 example Shandong Jincheng Pharmaceutical Group has 3 warning signs (and 1 which makes us a bit uncomfortable) we think 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.