These 4 Measures Indicate That Shanghai Fudan Microelectronics Group (HKG:1385) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. 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 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Net Debt?

As you can see below, at the end of March 2022, Shanghai Fudan Microelectronics Group had CN¥87.2m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.13b in cash, so it actually has CN¥1.04b net cash.

A Look At Shanghai Fudan Microelectronics Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Shanghai Fudan Microelectronics Group had liabilities of CN¥929.1m due within 12 months and liabilities of CN¥82.8m due beyond that. On the other hand, it had cash of CN¥1.13b and CN¥981.6m worth of receivables due within a year. So it can boast CN¥1.10b more liquid assets than total liabilities.

This surplus suggests that Shanghai Fudan Microelectronics Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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 511% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. In the last two years, Shanghai Fudan Microelectronics Group's free cash flow amounted to 23% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

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¥1.04b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 511% over the last year. So we don't think Shanghai Fudan Microelectronics Group's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Shanghai Fudan Microelectronics Group, you may well want to click here to check an interactive graph of its earnings per share history.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.