Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 note that IVD Medical Holding Limited (HKG:1931) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
Check out our latest analysis for IVD Medical Holding
What Is IVD Medical Holding's Debt?
As you can see below, IVD Medical Holding had CN¥408.8m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥841.8m in cash, so it actually has CN¥433.0m net cash.SEHK:1931 Debt to Equity History June 1st 2022
How Healthy Is IVD Medical Holding's Balance Sheet?
We can see from the most recent balance sheet that IVD Medical Holding had liabilities of CN¥1.16b falling due within a year, and liabilities of CN¥218.1m due beyond that. Offsetting these obligations, it had cash of CN¥841.8m as well as receivables valued at CN¥554.7m due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
Having regard to IVD Medical Holding's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥2.73b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, IVD Medical Holding boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that IVD Medical Holding grew its EBIT at 14% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since IVD Medical Holding will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. IVD Medical Holding 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. Over the most recent three years, IVD Medical Holding recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
While we empathize with investors who find debt concerning, you should keep in mind that IVD Medical Holding has net cash of CN¥433.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥138m, being 77% of its EBIT. So we don't think IVD Medical Holding's use of debt is risky. 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. For example - IVD Medical Holding has 2 warning signs we think you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.