Is SomnoMed (ASX:SOM) Using Debt Sensibly?

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. As with many other companies SomnoMed Limited (ASX:SOM) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for SomnoMed

What Is SomnoMed's Debt?

As you can see below, SomnoMed had AU$2.34m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has AU$17.6m in cash, leading to a AU$15.2m net cash position.

How Strong Is SomnoMed's Balance Sheet?

We can see from the most recent balance sheet that SomnoMed had liabilities of AU$18.2m falling due within a year, and liabilities of AU$6.93m due beyond that. Offsetting these obligations, it had cash of AU$17.6m as well as receivables valued at AU$10.7m due within 12 months. So it actually has AU$3.08m more liquid assets than total liabilities.

This short term liquidity is a sign that SomnoMed could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, SomnoMed boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine SomnoMed's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year SomnoMed wasn't profitable at an EBIT level, but managed to grow its revenue by 20%, to AU$66m. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is SomnoMed?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year SomnoMed had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of AU$6.0m and booked a AU$4.6m accounting loss. Given it only has net cash of AU$15.2m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for SomnoMed that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.