Is Topchoice Medical (SHSE:600763) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Topchoice Medical Co., Inc. (SHSE:600763) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Topchoice Medical

What Is Topchoice Medical's Debt?

As you can see below, Topchoice Medical had CN¥274.4m of debt at June 2024, down from CN¥323.8m a year prior. However, its balance sheet shows it holds CN¥623.1m in cash, so it actually has CN¥348.7m net cash.

A Look At Topchoice Medical's Liabilities

Zooming in on the latest balance sheet data, we can see that Topchoice Medical had liabilities of CN¥642.8m due within 12 months and liabilities of CN¥1.25b due beyond that. On the other hand, it had cash of CN¥623.1m and CN¥224.4m worth of receivables due within a year. So its liabilities total CN¥1.04b more than the combination of its cash and short-term receivables.

Since publicly traded Topchoice Medical shares are worth a total of CN¥23.4b, it seems unlikely that this level of liabilities would be a major 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, Topchoice Medical boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Topchoice Medical saw its EBIT drop by 5.2% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Topchoice Medical can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Topchoice Medical may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Topchoice Medical's free cash flow amounted to 44% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Topchoice Medical has CN¥348.7m in net cash. So we are not troubled with Topchoice Medical's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Topchoice Medical that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.