Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Hefei Chipmore Technology Co.,Ltd. (SHSE:688352) makes use of debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Hefei Chipmore TechnologyLtd's Debt?

As you can see below, Hefei Chipmore TechnologyLtd had CN¥435.9m of debt at June 2024, down from CN¥746.4m a year prior. But on the other hand it also has CN¥1.73b in cash, leading to a CN¥1.30b net cash position.

How Strong Is Hefei Chipmore TechnologyLtd's Balance Sheet?

The latest balance sheet data shows that Hefei Chipmore TechnologyLtd had liabilities of CN¥777.1m due within a year, and liabilities of CN¥301.9m falling due after that. On the other hand, it had cash of CN¥1.73b and CN¥257.5m worth of receivables due within a year. So it can boast CN¥912.7m 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!

In addition to that, we're happy to report that Hefei Chipmore TechnologyLtd has boosted its EBIT by 76%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hefei Chipmore TechnologyLtd'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, a company can only pay off debt with cold hard cash, not accounting profits. While Hefei Chipmore TechnologyLtd 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. Over the last three years, Hefei Chipmore TechnologyLtd saw substantial negative free cash flow, in total. 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 Hefei Chipmore TechnologyLtd has net cash of CN¥1.30b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 76% over the last year. So we are not troubled with Hefei Chipmore TechnologyLtd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Hefei Chipmore TechnologyLtd is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.