Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Compumedics Limited (ASX:CMP) has debt on its balance sheet. But should shareholders worry about its use of debt?
When is debt a problem?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for Compumedics
What is Compumedics debt?
As you can see below, at the end of December 2021, Compumedics had A$6.87 million in debt, up from A$3.69 million a year ago. Click on the image for more details. However, he has A$8.72 million in cash to offset this, which translates to a net cash of A$1.85 million.
How healthy is Compumedics’ balance sheet?
The latest balance sheet data shows that Compumedics had liabilities of A$16.5 million due within a year, and liabilities of A$683,000 falling due thereafter. In return, he had A$8.72 million in cash and A$10.9 million in debt due within 12 months. So he actually has 2.37 million Australian dollars After liquid assets than total liabilities.
This short-term liquidity is a sign that Compumedics could probably service its debt easily, as its balance sheet is far from stretched. In summary, Compumedics has clean cash, so it’s fair to say that it doesn’t have a lot of debt! The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since Compumedics will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Over the past year, Compumedics’ revenues have been fairly stable and achieved negative EBIT. While that’s hardly impressive, it’s not too bad either.
So how risky is Compumedics?
We have no doubt that loss-making companies are, in general, more risky than profitable companies. And the fact is that over the past twelve months, Compumedics has been losing money in earnings before interest and taxes (EBIT). Indeed, during this period, he burned A$16,000 in cash and suffered a loss of A$31,000. Given that it only has net cash of A$1.85 million, the company may need to raise more capital if it does not break even soon. Overall, its balance sheet doesn’t look too risky, at the moment, but we’re still cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Know that Compumedics shows 3 warning signs in our investment analysis and 1 of them is potentially serious…
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.