Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Crystal Clear Electronic Material Co., Ltd. (SZSE:300655) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Crystal Clear Electronic Material

How Much Debt Does Crystal Clear Electronic Material Carry?

As you can see below, at the end of March 2022, Crystal Clear Electronic Material had CN¥776.5m of debt, up from CN¥592.0m a year ago. Click the image for more detail. 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?

Zooming in on the latest balance sheet data, we can see that Crystal Clear Electronic Material had liabilities of CN¥565.2m due within 12 months and liabilities of CN¥577.6m due beyond that. On the other hand, it had cash of CN¥710.5m and CN¥497.9m worth of receivables due within a year. 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 while it's hard to imagine that the CN¥13.0b company is struggling for cash, we still think it's worth monitoring its 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.

With net debt sitting at just 0.25 times EBITDA, Crystal Clear Electronic Material is arguably pretty conservatively geared. And it boasts interest cover of 8.9 times, which is more than adequate. In addition to that, we're happy to report that Crystal Clear Electronic Material has boosted its EBIT by 87%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. 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 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Crystal Clear Electronic Material 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.

Our View

Crystal Clear Electronic Material's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Crystal Clear Electronic Material can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. Case in point: We've spotted 2 warning signs for Crystal Clear Electronic Material you should be aware of.

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.