Is CNSIG Inner Mongolia Chemical IndustryLtd (SHSE:600328) Using Too Much Debt?

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 CNSIG Inner Mongolia Chemical Industry Co.,Ltd. (SHSE:600328) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

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¥420.1m of debt at March 2024, down from CN¥1.24b a year prior. However, it does have CN¥1.11b in cash offsetting this, leading to net cash of CN¥694.2m.

A Look At CNSIG Inner Mongolia Chemical IndustryLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that CNSIG Inner Mongolia Chemical IndustryLtd had liabilities of CN¥4.13b due within 12 months and liabilities of CN¥706.9m due beyond that. On the other hand, it had cash of CN¥1.11b and CN¥1.96b worth of receivables due within a year. So its liabilities total CN¥1.77b more than the combination of its cash and short-term receivables.

Of course, CNSIG Inner Mongolia Chemical IndustryLtd has a market capitalization of CN¥12.0b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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.

In fact CNSIG Inner Mongolia Chemical IndustryLtd's saving grace is its low debt levels, because its EBIT has tanked 56% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. 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'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. 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. During the last three years, CNSIG Inner Mongolia Chemical IndustryLtd produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

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¥694.2m. So we don't have any problem with CNSIG Inner Mongolia Chemical IndustryLtd's use of debt. 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. For instance, we've identified 2 warning signs for CNSIG Inner Mongolia Chemical IndustryLtd that you should be aware of.

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.