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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Jiangyin Jianghua Microelectronics Materials Co., Ltd (SHSE:603078) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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 think about a company's use of debt, we first look at cash and debt together.

What Is Jiangyin Jianghua Microelectronics Materials's Debt?

As you can see below, at the end of June 2024, Jiangyin Jianghua Microelectronics Materials had CN¥708.8m of debt, up from CN¥312.4m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥856.3m in cash, so it actually has CN¥147.5m net cash.

A Look At Jiangyin Jianghua Microelectronics Materials' Liabilities

The latest balance sheet data shows that Jiangyin Jianghua Microelectronics Materials had liabilities of CN¥624.6m due within a year, and liabilities of CN¥308.1m falling due after that. Offsetting this, it had CN¥856.3m in cash and CN¥460.0m in receivables that were due within 12 months. So it can boast CN¥383.6m more liquid assets than total liabilities.

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

But the other side of the story is that Jiangyin Jianghua Microelectronics Materials saw its EBIT decline by 2.5% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Jiangyin Jianghua Microelectronics Materials can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Jiangyin Jianghua Microelectronics Materials 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. During the last three years, Jiangyin Jianghua Microelectronics Materials burned a lot of cash. 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.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Jiangyin Jianghua Microelectronics Materials has net cash of CN¥147.5m, as well as more liquid assets than liabilities. So we are not troubled with Jiangyin Jianghua Microelectronics Materials's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Jiangyin Jianghua Microelectronics Materials, you may well want to click here to check an interactive graph of its earnings per share history.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.