Here's Why Memphasys (ASX:MEM) Can Afford Some Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Memphasys Limited (ASX:MEM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Memphasys

What Is Memphasys's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2024 Memphasys had debt of AU$3.93m, up from AU$3.77m in one year. However, it does have AU$516.3k in cash offsetting this, leading to net debt of about AU$3.41m.

How Healthy Is Memphasys' Balance Sheet?

We can see from the most recent balance sheet that Memphasys had liabilities of AU$4.60m falling due within a year, and liabilities of AU$309.8k due beyond that. Offsetting these obligations, it had cash of AU$516.3k as well as receivables valued at AU$1.12m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$3.28m.

While this might seem like a lot, it is not so bad since Memphasys has a market capitalization of AU$14.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Memphasys will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Given it has no significant operating revenue at the moment, shareholders will be hoping Memphasys can make progress and gain better traction for the business, before it runs low on cash.

Caveat Emptor

Over the last twelve months Memphasys produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable AU$3.6m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled AU$3.6m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 6 warning signs for Memphasys you should be aware of, and 5 of them don't sit too well with us.

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.