Is SQI Diagnostics (CVE:SQD) Using Debt Sensibly?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies SQI Diagnostics Inc. (CVE:SQD) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for SQI Diagnostics

How Much Debt Does SQI Diagnostics Carry?

You can click the graphic below for the historical numbers, but it shows that SQI Diagnostics had CA$2.14m of debt in June 2020, down from CA$3.02m, one year before. However, it does have CA$4.32m in cash offsetting this, leading to net cash of CA$2.19m.

How Healthy Is SQI Diagnostics's Balance Sheet?

The latest balance sheet data shows that SQI Diagnostics had liabilities of CA$1.41m due within a year, and liabilities of CA$4.93m falling due after that. Offsetting these obligations, it had cash of CA$4.32m as well as receivables valued at CA$520.0k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$1.50m.

Having regard to SQI Diagnostics's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CA$78.4m company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, SQI Diagnostics also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is SQI Diagnostics's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, SQI Diagnostics made a loss at the EBIT level, and saw its revenue drop to CA$1.4m, which is a fall of 22%. To be frank that doesn't bode well.

So How Risky Is SQI Diagnostics?

Statistically speaking companies that lose money are riskier than those that make money. And in the last year SQI Diagnostics had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through CA$7.6m of cash and made a loss of CA$8.6m. With only CA$2.19m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 6 warning signs with SQI Diagnostics (at least 2 which can't be ignored) , and understanding them should be part of your investment process.

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. 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.
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