Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Jiangxi Fushine Pharmaceutical Co., Ltd. (SZSE:300497) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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.

Check out our latest analysis for Jiangxi Fushine Pharmaceutical

What Is Jiangxi Fushine Pharmaceutical's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Jiangxi Fushine Pharmaceutical had debt of CN¥1.37b, up from CN¥592.4m in one year. However, its balance sheet shows it holds CN¥1.45b in cash, so it actually has CN¥74.9m net cash.

A Look At Jiangxi Fushine Pharmaceutical's Liabilities

According to the last reported balance sheet, Jiangxi Fushine Pharmaceutical had liabilities of CN¥1.45b due within 12 months, and liabilities of CN¥636.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.45b as well as receivables valued at CN¥420.1m due within 12 months. So it has liabilities totalling CN¥216.4m more than its cash and near-term receivables, combined.

Of course, Jiangxi Fushine Pharmaceutical has a market capitalization of CN¥7.20b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Jiangxi Fushine Pharmaceutical boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Jiangxi Fushine Pharmaceutical's load is not too heavy, because its EBIT was down 69% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is Jiangxi Fushine 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Jiangxi Fushine Pharmaceutical 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, Jiangxi Fushine Pharmaceutical 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 look at a company's total liabilities, it is very reassuring that Jiangxi Fushine Pharmaceutical has CN¥74.9m in net cash. So although we see some areas for improvement, we're not too worried about Jiangxi Fushine Pharmaceutical's balance sheet. 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, we've discovered 3 warning signs for Jiangxi Fushine Pharmaceutical (1 is a bit unpleasant!) that you should be aware of before investing here.

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.