Here's Why Shanghai Fullhan Microelectronics (SZSE:300613) Can Manage Its Debt Responsibly

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. Importantly, Shanghai Fullhan Microelectronics Co., Ltd. (SZSE:300613) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shanghai Fullhan Microelectronics

What Is Shanghai Fullhan Microelectronics's Debt?

You can click the graphic below for the historical numbers, but it shows that Shanghai Fullhan Microelectronics had CN¥579.8m of debt in September 2024, down from CN¥637.3m, one year before. However, it does have CN¥1.76b in cash offsetting this, leading to net cash of CN¥1.18b.

How Healthy Is Shanghai Fullhan Microelectronics' Balance Sheet?

We can see from the most recent balance sheet that Shanghai Fullhan Microelectronics had liabilities of CN¥282.5m falling due within a year, and liabilities of CN¥582.8m due beyond that. Offsetting these obligations, it had cash of CN¥1.76b as well as receivables valued at CN¥472.1m due within 12 months. So it actually has CN¥1.37b more liquid assets than total liabilities.

This surplus suggests that Shanghai Fullhan Microelectronics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shanghai Fullhan Microelectronics boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Shanghai Fullhan Microelectronics's EBIT dived 13%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Fullhan Microelectronics'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Shanghai Fullhan Microelectronics 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, Shanghai Fullhan Microelectronics 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 we empathize with investors who find debt concerning, you should keep in mind that Shanghai Fullhan Microelectronics has net cash of CN¥1.18b, as well as more liquid assets than liabilities. The cherry on top was that in converted 120% of that EBIT to free cash flow, bringing in CN¥300m. So is Shanghai Fullhan Microelectronics's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Shanghai Fullhan Microelectronics (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

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.