These 4 Measures Indicate That Shenzhen China Micro Semicon (SHSE:688380) Is Using Debt Safely

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Shenzhen China Micro Semicon Co., Ltd. (SHSE:688380) does carry debt. But should shareholders be worried about its use of debt?

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What Risk Does Debt Bring?

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. 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.

What Is Shenzhen China Micro Semicon's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Shenzhen China Micro Semicon had debt of CN¥13.9m, up from none in one year. However, its balance sheet shows it holds CN¥956.0m in cash, so it actually has CN¥942.1m net cash.

A Look At Shenzhen China Micro Semicon's Liabilities

The latest balance sheet data shows that Shenzhen China Micro Semicon had liabilities of CN¥163.4m due within a year, and liabilities of CN¥22.9m falling due after that. Offsetting this, it had CN¥956.0m in cash and CN¥183.7m in receivables that were due within 12 months. So it actually has CN¥953.4m more liquid assets than total liabilities.

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

Check out our latest analysis for Shenzhen China Micro Semicon

Although Shenzhen China Micro Semicon made a loss at the EBIT level, last year, it was also good to see that it generated CN¥137m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shenzhen China Micro Semicon will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shenzhen China Micro Semicon 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. Over the last year, Shenzhen China Micro Semicon actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen China Micro Semicon has CN¥942.1m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 209% of that EBIT to free cash flow, bringing in CN¥287m. So we don't think Shenzhen China Micro Semicon's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Shenzhen China Micro Semicon is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.