David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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 note that HeraMED Limited (ASX:HMD) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does HeraMED Carry?
The image below, which you can click on for greater detail, shows that at June 2019 HeraMED had debt of US$161.9k, up from in one year. But on the other hand it also has US$2.55m in cash, leading to a US$2.38m net cash position.
How Strong Is HeraMED's Balance Sheet?
The latest balance sheet data shows that HeraMED had liabilities of US$424.6k due within a year, and liabilities of US$611.3k falling due after that. Offsetting these obligations, it had cash of US$2.55m as well as receivables valued at US$158.7k due within 12 months. So it actually has US$1.67m more liquid assets than total liabilities.
This excess liquidity suggests that HeraMED is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that HeraMED has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since HeraMED will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Given its lack of meaningful operating revenue, HeraMED shareholders no doubt hope it can fund itself until it can sell some of its new medical technology.
So How Risky Is HeraMED?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year HeraMED had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through US$3.2m of cash and made a loss of US$4.5m. With only US$2.38m on the balance sheet, it would appear that its going to need to raise capital again soon. The good news for shareholders is that HeraMED has dazzling revenue growth, so there's a very good chance it can boost its free cash flow in the years to come. While unprofitable companies can be risky, they can also grow hard and fast in those pre-profit years. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how HeraMED's profit, revenue, and operating cashflow have changed over the last few years.
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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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.