Warren Buffett famously said, '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. As with many other companies ADMA Biologics, Inc. (NASDAQ:ADMA) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is ADMA Biologics's Net Debt?

The image below, which you can click on for greater detail, shows that ADMA Biologics had debt of US$130.6m at the end of December 2023, a reduction from US$142.8m over a year. However, it does have US$51.4m in cash offsetting this, leading to net debt of about US$79.2m.

How Strong Is ADMA Biologics' Balance Sheet?

We can see from the most recent balance sheet that ADMA Biologics had liabilities of US$49.8m falling due within a year, and liabilities of US$144.2m due beyond that. On the other hand, it had cash of US$51.4m and US$27.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$115.2m.

Of course, ADMA Biologics has a market capitalization of US$1.45b, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While ADMA Biologics has a quite reasonable net debt to EBITDA multiple of 2.4, its interest cover seems weak, at 1.0. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. However, the silver lining was that ADMA Biologics achieved a positive EBIT of US$24m in the last twelve months, an improvement on the prior year's loss. 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 ADMA Biologics 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, ADMA Biologics reported free cash flow worth 16% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

ADMA Biologics's interest cover was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its level of total liabilities is relatively strong. When we consider all the factors discussed, it seems to us that ADMA Biologics is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. 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 1 warning sign for ADMA Biologics 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.