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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Zai Lab Limited (NASDAQ:ZLAB) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

What Is Zai Lab's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Zai Lab had US$70.3m of debt, an increase on none, over one year. However, it does have US$630.0m in cash offsetting this, leading to net cash of US$559.8m.

How Healthy Is Zai Lab's Balance Sheet?

According to the last reported balance sheet, Zai Lab had liabilities of US$251.7m due within 12 months, and liabilities of US$31.5m due beyond 12 months. Offsetting this, it had US$630.0m in cash and US$77.7m in receivables that were due within 12 months. So it can boast US$424.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Zai Lab could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Zai Lab has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Zai Lab'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.

In the last year Zai Lab wasn't profitable at an EBIT level, but managed to grow its revenue by 28%, to US$323m. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Zai Lab?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Zai Lab had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of US$215m and booked a US$298m accounting loss. But the saving grace is the US$559.8m on the balance sheet. That means it could keep spending at its current rate for more than two years. Zai Lab's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. For riskier companies like Zai Lab I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

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.