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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Crystal Clear Electronic Material Co., Ltd. (SZSE:300655) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Crystal Clear Electronic Material

What Is Crystal Clear Electronic Material's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Crystal Clear Electronic Material had CN¥776.5m of debt, an increase on CN¥592.0m, over one year. However, it also had CN¥710.5m in cash, and so its net debt is CN¥66.1m.

How Healthy Is Crystal Clear Electronic Material's Balance Sheet?

The latest balance sheet data shows that Crystal Clear Electronic Material had liabilities of CN¥565.2m due within a year, and liabilities of CN¥577.6m falling due after that. Offsetting these obligations, it had cash of CN¥710.5m as well as receivables valued at CN¥497.9m due within 12 months. So it actually has CN¥65.6m more liquid assets than total liabilities.

Having regard to Crystal Clear Electronic Material's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥7.80b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Crystal Clear Electronic Material has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Crystal Clear Electronic Material has net debt of just 0.23 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. Better yet, Crystal Clear Electronic Material grew its EBIT by 119% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Crystal Clear Electronic Material's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Crystal Clear Electronic Material saw substantial negative free cash flow, in total. 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.

Our View

The good news is that Crystal Clear Electronic Material's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. When we consider the range of factors above, it looks like Crystal Clear Electronic Material is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. For example, we've discovered 2 warning signs for Crystal Clear Electronic Material that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.