Does CNSIG Inner Mongolia Chemical IndustryLtd (SHSE:600328) Have A Healthy Balance Sheet?

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. Importantly, CNSIG Inner Mongolia Chemical Industry Co.,Ltd. (SHSE:600328) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for CNSIG Inner Mongolia Chemical IndustryLtd

What Is CNSIG Inner Mongolia Chemical IndustryLtd's Net Debt?

As you can see below, CNSIG Inner Mongolia Chemical IndustryLtd had CN¥767.1m of debt at June 2024, down from CN¥1.38b a year prior. But on the other hand it also has CN¥948.2m in cash, leading to a CN¥181.1m net cash position.

How Healthy Is CNSIG Inner Mongolia Chemical IndustryLtd's Balance Sheet?

We can see from the most recent balance sheet that CNSIG Inner Mongolia Chemical IndustryLtd had liabilities of CN¥4.86b falling due within a year, and liabilities of CN¥689.5m due beyond that. Offsetting these obligations, it had cash of CN¥948.2m as well as receivables valued at CN¥2.57b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.03b.

Of course, CNSIG Inner Mongolia Chemical IndustryLtd has a market capitalization of CN¥12.5b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, CNSIG Inner Mongolia Chemical IndustryLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for CNSIG Inner Mongolia Chemical IndustryLtd if management cannot prevent a repeat of the 48% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine CNSIG Inner Mongolia Chemical IndustryLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. CNSIG Inner Mongolia Chemical IndustryLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, CNSIG Inner Mongolia Chemical IndustryLtd recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although CNSIG Inner Mongolia Chemical IndustryLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥181.1m. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in CN¥729m. So we don't have any problem with CNSIG Inner Mongolia Chemical IndustryLtd's use of debt. 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. Be aware that CNSIG Inner Mongolia Chemical IndustryLtd is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.