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.' 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 Chengdu Easton Biopharmaceuticals Co., Ltd. (SHSE:688513) does use debt in its business. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Chengdu Easton Biopharmaceuticals Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Chengdu Easton Biopharmaceuticals had CN¥175.1m of debt, an increase on CN¥105.3m, over one year. But it also has CN¥1.42b in cash to offset that, meaning it has CN¥1.24b net cash.

How Strong Is Chengdu Easton Biopharmaceuticals' Balance Sheet?

The latest balance sheet data shows that Chengdu Easton Biopharmaceuticals had liabilities of CN¥557.8m due within a year, and liabilities of CN¥86.5m falling due after that. Offsetting this, it had CN¥1.42b in cash and CN¥188.4m in receivables that were due within 12 months. So it can boast CN¥959.9m more liquid assets than total liabilities.

This excess liquidity suggests that Chengdu Easton Biopharmaceuticals is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Chengdu Easton Biopharmaceuticals has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Chengdu Easton Biopharmaceuticals grew its EBIT by 55% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Chengdu Easton Biopharmaceuticals's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Chengdu Easton Biopharmaceuticals 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. Over the last three years, Chengdu Easton Biopharmaceuticals saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Chengdu Easton Biopharmaceuticals has CN¥1.24b in net cash and a decent-looking balance sheet. And we liked the look of last year's 55% year-on-year EBIT growth. So we don't think Chengdu Easton Biopharmaceuticals's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Chengdu Easton Biopharmaceuticals .

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.