China Resources Microelectronics (SHSE:688396) Has A Somewhat Strained Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that China Resources Microelectronics Limited (SHSE:688396) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for China Resources Microelectronics

How Much Debt Does China Resources Microelectronics Carry?

You can click the graphic below for the historical numbers, but it shows that China Resources Microelectronics had CN¥956.7m of debt in March 2024, down from CN¥1.36b, one year before. But it also has CN¥9.03b in cash to offset that, meaning it has CN¥8.07b net cash.

How Healthy Is China Resources Microelectronics' Balance Sheet?

We can see from the most recent balance sheet that China Resources Microelectronics had liabilities of CN¥5.18b falling due within a year, and liabilities of CN¥401.4m due beyond that. Offsetting this, it had CN¥9.03b in cash and CN¥2.18b in receivables that were due within 12 months. So it can boast CN¥5.63b more liquid assets than total liabilities.

This short term liquidity is a sign that China Resources Microelectronics could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that China Resources Microelectronics has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for China Resources Microelectronics if management cannot prevent a repeat of the 44% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if China Resources Microelectronics can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While China Resources Microelectronics 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. During the last three years, China Resources Microelectronics burned a lot of cash. 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 it is always sensible to investigate a company's debt, in this case China Resources Microelectronics has CN¥8.07b in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about China Resources Microelectronics's balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for China Resources Microelectronics (of which 1 can't be ignored!) you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com