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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Epoxy Base Electronic Material Corporation Limited (SHSE:603002) does have debt on its balance sheet. 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. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

What Is Epoxy Base Electronic Material's Debt?

As you can see below, Epoxy Base Electronic Material had CN¥252.9m of debt at September 2024, down from CN¥326.6m a year prior. However, it does have CN¥1.54b in cash offsetting this, leading to net cash of CN¥1.28b.

How Strong Is Epoxy Base Electronic Material's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Epoxy Base Electronic Material had liabilities of CN¥934.8m due within 12 months and liabilities of CN¥224.8m due beyond that. On the other hand, it had cash of CN¥1.54b and CN¥906.6m worth of receivables due within a year. So it actually has CN¥1.28b more liquid assets than total liabilities.

It's good to see that Epoxy Base Electronic Material has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Epoxy Base Electronic Material boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Epoxy Base Electronic Material's saving grace is its low debt levels, because its EBIT has tanked 57% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Epoxy Base Electronic Material can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Epoxy Base Electronic Material 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, Epoxy Base Electronic Material 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 Epoxy Base Electronic Material has net cash of CN¥1.28b, as well as more liquid assets than liabilities. So we don't have any problem with Epoxy Base Electronic Material's use of debt. 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. Case in point: We've spotted 4 warning signs for Epoxy Base Electronic Material you should be aware of, and 2 of them are a bit 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.

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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.