Crystal Clear Electronic MaterialLtd (SZSE:300655) Takes On Some Risk With Its Use Of Debt

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Crystal Clear Electronic Material Co.,Ltd (SZSE:300655) does use debt in its business. But is this debt a concern to shareholders?

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 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Crystal Clear Electronic MaterialLtd

What Is Crystal Clear Electronic MaterialLtd's Net Debt?

As you can see below, Crystal Clear Electronic MaterialLtd had CN¥824.1m of debt at September 2024, down from CN¥1.03b a year prior. However, its balance sheet shows it holds CN¥1.56b in cash, so it actually has CN¥740.7m net cash.

How Strong Is Crystal Clear Electronic MaterialLtd's Balance Sheet?

According to the last reported balance sheet, Crystal Clear Electronic MaterialLtd had liabilities of CN¥455.0m due within 12 months, and liabilities of CN¥1.05b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.56b as well as receivables valued at CN¥592.7m due within 12 months. So it actually has CN¥651.9m more liquid assets than total liabilities.

This surplus suggests that Crystal Clear Electronic MaterialLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Crystal Clear Electronic MaterialLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Shareholders should be aware that Crystal Clear Electronic MaterialLtd's EBIT was down 64% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Crystal Clear Electronic MaterialLtd can strengthen its balance sheet over time. 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. Crystal Clear Electronic MaterialLtd 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 last three years, Crystal Clear Electronic MaterialLtd 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 Crystal Clear Electronic MaterialLtd has net cash of CN¥740.7m, as well as more liquid assets than liabilities. Despite the cash, we do find Crystal Clear Electronic MaterialLtd's EBIT growth rate concerning, so we're not particularly comfortable with the stock. 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. We've identified 2 warning signs with Crystal Clear Electronic MaterialLtd (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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.

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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.