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. As with many other companies Crystal Clear Electronic Material Co.,Ltd (SZSE:300655) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Crystal Clear Electronic MaterialLtd's Net Debt?

As you can see below, at the end of September 2023, Crystal Clear Electronic MaterialLtd had CN¥1.03b of debt, up from CN¥866.9m a year ago. Click the image for more detail. However, it also had CN¥854.5m in cash, and so its net debt is CN¥171.2m.

How Strong Is Crystal Clear Electronic MaterialLtd's Balance Sheet?

The latest balance sheet data shows that Crystal Clear Electronic MaterialLtd had liabilities of CN¥767.5m due within a year, and liabilities of CN¥877.8m falling due after that. On the other hand, it had cash of CN¥854.5m and CN¥571.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥219.8m.

Of course, Crystal Clear Electronic MaterialLtd has a market capitalization of CN¥7.67b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 0.80 and interest cover of 5.0 times, it seems to us that Crystal Clear Electronic MaterialLtd is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, Crystal Clear Electronic MaterialLtd's EBIT fell a jaw-dropping 35% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Crystal Clear Electronic MaterialLtd 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Crystal Clear Electronic MaterialLtd 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

To be frank both Crystal Clear Electronic MaterialLtd's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Crystal Clear Electronic MaterialLtd stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Over time, share prices tend to follow earnings per share, so if you're interested in Crystal Clear Electronic MaterialLtd, you may well want to click here to check an interactive graph of its earnings per share history.

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.