Is Zoom2u Technologies (ASX:Z2U) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Zoom2u Technologies Limited (ASX:Z2U) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Zoom2u Technologies

How Much Debt Does Zoom2u Technologies Carry?

As you can see below, at the end of June 2024, Zoom2u Technologies had AU$3.57m of debt, up from AU$3.37m a year ago. Click the image for more detail. However, because it has a cash reserve of AU$2.05m, its net debt is less, at about AU$1.51m.

How Healthy Is Zoom2u Technologies' Balance Sheet?

According to the last reported balance sheet, Zoom2u Technologies had liabilities of AU$1.30m due within 12 months, and liabilities of AU$4.05m due beyond 12 months. Offsetting these obligations, it had cash of AU$2.05m as well as receivables valued at AU$599.8k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$2.69m.

Of course, Zoom2u Technologies has a market capitalization of AU$15.9m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Zoom2u Technologies 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.

In the last year Zoom2u Technologies wasn't profitable at an EBIT level, but managed to grow its revenue by 24%, to AU$5.8m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though Zoom2u Technologies managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost a very considerable AU$2.0m 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled AU$1.8m 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. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Zoom2u Technologies (at least 3 which make us uncomfortable) , and understanding them should be part of your investment process.

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. 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.