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.' 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 China Resources Chemical Innovative Materials Co., Ltd. (SZSE:301090) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is China Resources Chemical Innovative Materials's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2024 China Resources Chemical Innovative Materials had debt of CN¥311.5m, up from CN¥12.0m in one year. But it also has CN¥880.0m in cash to offset that, meaning it has CN¥568.5m net cash.
How Strong Is China Resources Chemical Innovative Materials' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that China Resources Chemical Innovative Materials had liabilities of CN¥2.84b due within 12 months and liabilities of CN¥189.0m due beyond that. Offsetting this, it had CN¥880.0m in cash and CN¥1.04b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.11b more than its cash and near-term receivables, combined.
Given China Resources Chemical Innovative Materials has a market capitalization of CN¥13.1b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, China Resources Chemical Innovative Materials boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact China Resources Chemical Innovative Materials's saving grace is its low debt levels, because its EBIT has tanked 79% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Resources Chemical Innovative Materials'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China Resources Chemical Innovative Materials 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, China Resources Chemical Innovative Materials burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing Up
We could understand if investors are concerned about China Resources Chemical Innovative Materials's liabilities, but we can be reassured by the fact it has has net cash of CN¥568.5m. So while China Resources Chemical Innovative Materials does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with China Resources Chemical Innovative Materials (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.
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.
