Does Shanghai Fudan Microelectronics Group (HKG:1385) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Shanghai Fudan Microelectronics Group Company Limited (HKG:1385) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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.

See our latest analysis for Shanghai Fudan Microelectronics Group

What Is Shanghai Fudan Microelectronics Group's Debt?

As you can see below, at the end of December 2021, Shanghai Fudan Microelectronics Group had CN¥50.0m of debt, up from none a year ago. Click the image for more detail. But it also has CN¥1.19b in cash to offset that, meaning it has CN¥1.14b net cash.

A Look At Shanghai Fudan Microelectronics Group's Liabilities

We can see from the most recent balance sheet that Shanghai Fudan Microelectronics Group had liabilities of CN¥713.1m falling due within a year, and liabilities of CN¥85.0m due beyond that. On the other hand, it had cash of CN¥1.19b and CN¥842.5m worth of receivables due within a year. So it can boast CN¥1.24b more liquid assets than total liabilities.

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

Better yet, Shanghai Fudan Microelectronics Group grew its EBIT by 670% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shanghai Fudan Microelectronics Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shanghai Fudan Microelectronics Group 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 two years, Shanghai Fudan Microelectronics Group reported free cash flow worth 5.0% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Fudan Microelectronics Group has net cash of CN¥1.14b, as well as more liquid assets than liabilities. And we liked the look of last year's 670% year-on-year EBIT growth. So we don't think Shanghai Fudan Microelectronics Group's use of debt is risky. 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. For example, we've discovered 3 warning signs for Shanghai Fudan Microelectronics Group (1 is significant!) that you should be aware of before investing here.

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.