Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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 Cytosorbents Corporation (NASDAQ:CTSO) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Cytosorbents Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 Cytosorbents had US$15.1m of debt, an increase on US$9.96m, over one year. But it also has US$26.4m in cash to offset that, meaning it has US$11.3m net cash.
A Look At Cytosorbents's Liabilities
The latest balance sheet data shows that Cytosorbents had liabilities of US$11.5m due within a year, and liabilities of US$11.4m falling due after that. On the other hand, it had cash of US$26.4m and US$5.40m worth of receivables due within a year. So it actually has US$8.87m more liquid assets than total liabilities.
This short term liquidity is a sign that Cytosorbents could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Cytosorbents has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Cytosorbents's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Cytosorbents wasn't profitable at an EBIT level, but managed to grow its revenue by 25%, to US$28m. Shareholders probably have their fingers crossed that it can grow its way to profits.
So How Risky Is Cytosorbents?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Cytosorbents had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through US$17m of cash and made a loss of US$18m. But at least it has US$11.3m on the balance sheet to spend on growth, near-term. With very solid revenue growth in the last year, Cytosorbents may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Cytosorbents 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.
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This article by Simply Wall St is general in nature. 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. Thank you for reading.