SomnoMed (ASX:SOM) Has Debt But No Earnings; Should You Worry?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that SomnoMed Limited (ASX:SOM) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for SomnoMed

What Is SomnoMed's Debt?

As you can see below, SomnoMed had AU$12.0m of debt at December 2023, down from AU$16.8m a year prior. But on the other hand it also has AU$12.8m in cash, leading to a AU$882.5k net cash position.

A Look At SomnoMed's Liabilities

According to the last reported balance sheet, SomnoMed had liabilities of AU$17.5m due within 12 months, and liabilities of AU$16.6m due beyond 12 months. Offsetting this, it had AU$12.8m in cash and AU$12.6m in receivables that were due within 12 months. So its liabilities total AU$8.62m more than the combination of its cash and short-term receivables.

Given SomnoMed has a market capitalization of AU$46.7m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, 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 ultimately the future profitability of the business will decide if SomnoMed 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.

In the last year SomnoMed wasn't profitable at an EBIT level, but managed to grow its revenue by 13%, to AU$89m. 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 the fact is that over the last twelve months SomnoMed lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of AU$9.6m and booked a AU$11m accounting loss. However, it has net cash of AU$882.5k, so it has a bit of time before it will need more capital. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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. To that end, you should learn about the 3 warning signs we've spotted with SomnoMed (including 1 which shouldn't be ignored) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.