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 can see that Double Medical Technology Inc. (SZSE:002901) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Double Medical Technology
What Is Double Medical Technology's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2023 Double Medical Technology had CN¥342.2m of debt, an increase on CN¥30.8m, over one year. But it also has CN¥1.42b in cash to offset that, meaning it has CN¥1.08b net cash.
How Strong Is Double Medical Technology's Balance Sheet?
According to the last reported balance sheet, Double Medical Technology had liabilities of CN¥876.4m due within 12 months, and liabilities of CN¥244.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.42b as well as receivables valued at CN¥345.4m due within 12 months. So it actually has CN¥644.0m more liquid assets than total liabilities.
This surplus suggests that Double Medical Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Double Medical Technology has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Double Medical Technology'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.
In the last year Double Medical Technology had a loss before interest and tax, and actually shrunk its revenue by 31%, to CN¥1.4b. To be frank that doesn't bode well.
So How Risky Is Double Medical Technology?
While Double Medical Technology lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥5.6m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. 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. We've identified 2 warning signs with Double Medical Technology , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.