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.' 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. We can see that SonoScape Medical Corp. (SZSE:300633) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for SonoScape Medical
What Is SonoScape Medical's Debt?
You can click the graphic below for the historical numbers, but it shows that SonoScape Medical had CN¥104.2m of debt in September 2023, down from CN¥139.1m, one year before. However, it does have CN¥1.75b in cash offsetting this, leading to net cash of CN¥1.64b.
A Look At SonoScape Medical's Liabilities
The latest balance sheet data shows that SonoScape Medical had liabilities of CN¥599.9m due within a year, and liabilities of CN¥54.2m falling due after that. Offsetting this, it had CN¥1.75b in cash and CN¥198.2m in receivables that were due within 12 months. So it actually has CN¥1.29b more liquid assets than total liabilities.
This short term liquidity is a sign that SonoScape Medical could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that SonoScape Medical has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that SonoScape Medical has boosted its EBIT by 33%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if SonoScape Medical 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. SonoScape Medical 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, SonoScape Medical produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that SonoScape Medical has net cash of CN¥1.64b, as well as more liquid assets than liabilities. And we liked the look of last year's 33% year-on-year EBIT growth. So is SonoScape Medical's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in SonoScape Medical, 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.