David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Jiangsu Sinopep-Allsino Biopharmaceutical Co., Ltd. (SHSE:688076) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Jiangsu Sinopep-Allsino Biopharmaceutical's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Jiangsu Sinopep-Allsino Biopharmaceutical had debt of CN¥1.04b, up from CN¥418.7m in one year. However, because it has a cash reserve of CN¥744.2m, its net debt is less, at about CN¥295.5m.

How Strong Is Jiangsu Sinopep-Allsino Biopharmaceutical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jiangsu Sinopep-Allsino Biopharmaceutical had liabilities of CN¥1.06b due within 12 months and liabilities of CN¥387.3m due beyond that. Offsetting this, it had CN¥744.2m in cash and CN¥338.6m in receivables that were due within 12 months. So its liabilities total CN¥368.1m more than the combination of its cash and short-term receivables.

Given Jiangsu Sinopep-Allsino Biopharmaceutical has a market capitalization of CN¥12.1b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Jiangsu Sinopep-Allsino Biopharmaceutical has a low net debt to EBITDA ratio of only 0.78. And its EBIT easily covers its interest expense, being 22.5 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Jiangsu Sinopep-Allsino Biopharmaceutical grew its EBIT by 159% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Jiangsu Sinopep-Allsino Biopharmaceutical'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Jiangsu Sinopep-Allsino Biopharmaceutical saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Jiangsu Sinopep-Allsino Biopharmaceutical's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Jiangsu Sinopep-Allsino Biopharmaceutical can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Jiangsu Sinopep-Allsino Biopharmaceutical you should be aware of, and 1 of them is potentially serious.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.