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 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 China Resources Microelectronics Limited (SHSE:688396) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. 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 Microelectronics's Net Debt?

As you can see below, China Resources Microelectronics had CN¥956.7m of debt at March 2024, down from CN¥1.36b a year prior. But it also has CN¥9.03b in cash to offset that, meaning it has CN¥8.07b net cash.

A Look At China Resources Microelectronics' Liabilities

We can see from the most recent balance sheet that China Resources Microelectronics had liabilities of CN¥5.18b falling due within a year, and liabilities of CN¥401.4m due beyond that. On the other hand, it had cash of CN¥9.03b and CN¥2.18b worth of receivables due within a year. So it actually has CN¥5.63b more liquid assets than total liabilities.

This short term liquidity is a sign that China Resources Microelectronics could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, China Resources Microelectronics boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for China Resources Microelectronics if management cannot prevent a repeat of the 44% cut to EBIT over the last year. 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 ultimately the future profitability of the business will decide if China Resources Microelectronics 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. While China Resources Microelectronics 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 Microelectronics 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

While it is always sensible to investigate a company's debt, in this case China Resources Microelectronics has CN¥8.07b in net cash and a decent-looking balance sheet. So while China Resources Microelectronics does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for China Resources Microelectronics you should be aware of, and 1 of them is concerning.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.