Amoy Diagnostics (SZSE:300685) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, Amoy Diagnostics Co., Ltd. (SZSE:300685) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Amoy Diagnostics

What Is Amoy Diagnostics's Debt?

As you can see below, at the end of December 2023, Amoy Diagnostics had CN¥54.5m of debt, up from CN¥48.9m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.02b in cash, leading to a CN¥967.4m net cash position.

How Strong Is Amoy Diagnostics' Balance Sheet?

The latest balance sheet data shows that Amoy Diagnostics had liabilities of CN¥174.5m due within a year, and liabilities of CN¥57.1m falling due after that. Offsetting this, it had CN¥1.02b in cash and CN¥539.5m in receivables that were due within 12 months. So it can boast CN¥1.33b more liquid assets than total liabilities.

This surplus suggests that Amoy Diagnostics is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Amoy Diagnostics has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Amoy Diagnostics grew its EBIT by 107% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Amoy Diagnostics 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. While Amoy Diagnostics 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, Amoy Diagnostics produced sturdy free cash flow equating to 62% 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 Amoy Diagnostics has CN¥967.4m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 107% over the last year. So we don't think Amoy Diagnostics's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Amoy Diagnostics, you may well want to click here to check an interactive graph of its earnings per share history.

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.