McChip Resources (CVE:MCS) Has Debt But No Earnings; Should You Worry?

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.' 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 can see that McChip Resources Inc. (CVE:MCS) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for McChip Resources

What Is McChip Resources's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 McChip Resources had debt of CA$2.05m, up from CA$718.9k in one year. However, it does have CA$7.85m in cash offsetting this, leading to net cash of CA$5.81m.

A Look At McChip Resources' Liabilities

Zooming in on the latest balance sheet data, we can see that McChip Resources had liabilities of CA$2.21m due within 12 months and liabilities of CA$33.2k due beyond that. Offsetting these obligations, it had cash of CA$7.85m as well as receivables valued at CA$488.5k due within 12 months. So it actually has CA$6.10m more liquid assets than total liabilities.

This surplus strongly suggests that McChip Resources has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, McChip Resources boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since McChip Resources will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year McChip Resources had a loss before interest and tax, and actually shrunk its revenue by 96%, to CA$67k. That makes us nervous, to say the least.

So How Risky Is McChip Resources?

Statistically speaking companies that lose money are riskier than those that make money. And we do note that McChip Resources had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through CA$166k of cash and made a loss of CA$668k. Given it only has net cash of CA$5.81m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. Case in point: We've spotted 5 warning signs for McChip Resources 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.