The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Miracll Chemicals Co.,Ltd (SZSE:300848) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Miracll ChemicalsLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Miracll ChemicalsLtd had CN¥506.4m of debt, an increase on CN¥119.5m, over one year. However, its balance sheet shows it holds CN¥837.2m in cash, so it actually has CN¥330.8m net cash.

How Healthy Is Miracll ChemicalsLtd's Balance Sheet?

We can see from the most recent balance sheet that Miracll ChemicalsLtd had liabilities of CN¥928.9m falling due within a year, and liabilities of CN¥527.9m due beyond that. Offsetting these obligations, it had cash of CN¥837.2m as well as receivables valued at CN¥307.0m due within 12 months. So it has liabilities totalling CN¥312.6m more than its cash and near-term receivables, combined.

Given Miracll ChemicalsLtd has a market capitalization of CN¥5.64b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Miracll ChemicalsLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Miracll ChemicalsLtd if management cannot prevent a repeat of the 30% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Miracll ChemicalsLtd'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, a company can only pay off debt with cold hard cash, not accounting profits. Miracll ChemicalsLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Miracll ChemicalsLtd 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.

Summing Up

We could understand if investors are concerned about Miracll ChemicalsLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥330.8m. So while Miracll ChemicalsLtd does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Miracll ChemicalsLtd (of which 1 can't be ignored!) you should know about.

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.