These 4 Measures Indicate That SonoScape Medical (SZSE:300633) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies SonoScape Medical Corp. (SZSE:300633) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for SonoScape Medical

How Much Debt Does SonoScape Medical Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 SonoScape Medical had CN¥351.5m of debt, an increase on CN¥154.4m, over one year. However, its balance sheet shows it holds CN¥1.93b in cash, so it actually has CN¥1.58b net cash.

How Strong Is SonoScape Medical's Balance Sheet?

The latest balance sheet data shows that SonoScape Medical had liabilities of CN¥893.7m due within a year, and liabilities of CN¥98.8m falling due after that. Offsetting these obligations, it had cash of CN¥1.93b as well as receivables valued at CN¥256.0m due within 12 months. So it can boast CN¥1.19b more liquid assets than total liabilities.

This short term liquidity is a sign that SonoScape Medical could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, SonoScape Medical boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that SonoScape Medical's load is not too heavy, because its EBIT was down 31% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if SonoScape Medical 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While SonoScape Medical has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, SonoScape Medical produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case SonoScape Medical has CN¥1.58b in net cash and a decent-looking balance sheet. So we don't have any problem with SonoScape Medical's use of debt. 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 SonoScape Medical that you should be aware of before investing here.

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.