These 4 Measures Indicate That Jin Yang Pharmaceutical (KOSDAQ:007370) Is Using Debt Reasonably Well

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. As with many other companies Jin Yang Pharmaceutical Co., Ltd. (KOSDAQ:007370) makes use of debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Jin Yang Pharmaceutical

What Is Jin Yang Pharmaceutical's Debt?

You can click the graphic below for the historical numbers, but it shows that Jin Yang Pharmaceutical had ₩13.1b of debt in March 2024, down from ₩20.1b, one year before. On the flip side, it has ₩11.2b in cash leading to net debt of about ₩1.93b.

How Strong Is Jin Yang Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Jin Yang Pharmaceutical had liabilities of ₩28.5b due within a year, and liabilities of ₩5.97b falling due after that. Offsetting this, it had ₩11.2b in cash and ₩22.3b in receivables that were due within 12 months. So its liabilities total ₩961.3m more than the combination of its cash and short-term receivables.

Having regard to Jin Yang Pharmaceutical's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₩61.6b company is struggling for cash, we still think it's worth monitoring its balance sheet.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Jin Yang Pharmaceutical has net debt of just 0.18 times EBITDA, suggesting it could ramp leverage without breaking a sweat. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt while staying cool as a cucumber. The modesty of its debt load may become crucial for Jin Yang Pharmaceutical if management cannot prevent a repeat of the 37% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Jin Yang 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Jin Yang Pharmaceutical recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Jin Yang Pharmaceutical's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that Jin Yang Pharmaceutical is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. Be aware that Jin Yang Pharmaceutical is showing 3 warning signs in our investment analysis , you should know about...

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.