The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Jin Medical International Ltd. (NASDAQ:ZJYL) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Jin Medical International's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Jin Medical International had debt of US$9.68m, up from US$1.46m in one year. But on the other hand it also has US$26.0m in cash, leading to a US$16.3m net cash position.

How Strong Is Jin Medical International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jin Medical International had liabilities of US$14.8m due within 12 months and liabilities of US$179.7k due beyond that. Offsetting this, it had US$26.0m in cash and US$5.54m in receivables that were due within 12 months. So it actually has US$16.5m more liquid assets than total liabilities.

This surplus suggests that Jin Medical International has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Jin Medical International has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Jin Medical International's EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is Jin Medical International'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Jin Medical International has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Jin Medical International produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Jin Medical International has net cash of US$16.3m, as well as more liquid assets than liabilities. The cherry on top was that in converted 79% of that EBIT to free cash flow, bringing in -US$754k. So we are not troubled with Jin Medical International's debt use. 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. For instance, we've identified 2 warning signs for Jin Medical International that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.