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. As with many other companies Hefei Chipmore Technology Co.,Ltd. (SHSE:688352) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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 Hefei Chipmore TechnologyLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Hefei Chipmore TechnologyLtd had CN¥705.5m of debt in September 2023, down from CN¥1.15b, one year before. However, it does have CN¥2.28b in cash offsetting this, leading to net cash of CN¥1.57b.

How Strong Is Hefei Chipmore TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Hefei Chipmore TechnologyLtd had liabilities of CN¥802.7m falling due within a year, and liabilities of CN¥585.0m due beyond that. Offsetting these obligations, it had cash of CN¥2.28b as well as receivables valued at CN¥228.5m due within 12 months. So it actually has CN¥1.12b more liquid assets than total liabilities.

This surplus suggests that Hefei Chipmore TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Hefei Chipmore TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Hefei Chipmore TechnologyLtd has seen its EBIT plunge 15% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is Hefei Chipmore TechnologyLtd's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Hefei Chipmore TechnologyLtd 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. Over the last three years, Hefei Chipmore TechnologyLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hefei Chipmore TechnologyLtd has CN¥1.57b in net cash and a decent-looking balance sheet. So we don't have any problem with Hefei Chipmore TechnologyLtd's use of debt. 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. Case in point: We've spotted 1 warning sign for Hefei Chipmore TechnologyLtd 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.