Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Innovative Pharmaceutical Biotech Limited (HKG:399) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Innovative Pharmaceutical Biotech

How Much Debt Does Innovative Pharmaceutical Biotech Carry?

The image below, which you can click on for greater detail, shows that at March 2019 Innovative Pharmaceutical Biotech had debt of HK$713.5m, up from HK$586.1m in one year. However, it also had HK$17.1m in cash, and so its net debt is HK$696.4m.

A Look At Innovative Pharmaceutical Biotech's Liabilities

We can see from the most recent balance sheet that Innovative Pharmaceutical Biotech had liabilities of HK$32.4m falling due within a year, and liabilities of HK$751.5m due beyond that. On the other hand, it had cash of HK$17.1m and HK$21.2m worth of receivables due within a year. So its liabilities total HK$745.7m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's HK$519.8m market capitalization, you might well be inclined to review the balance sheet, just like one might study a new partner's social media. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Innovative Pharmaceutical Biotech will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Innovative Pharmaceutical Biotech reported revenue of HK$19m, which is a gain of 18%. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Innovative Pharmaceutical Biotech had negative earnings before interest and tax (EBIT), over the last year. To be specific the EBIT loss came in at HK$27m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of-HK$260.3m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Innovative Pharmaceutical Biotech's profit, revenue, and operating cashflow have changed over the last few years.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.