Does Diagnostic Medical Systems (EPA:ALDMS) Have A Healthy Balance Sheet?

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. Importantly, Diagnostic Medical Systems S.A. (EPA:ALDMS) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

View our latest analysis for Diagnostic Medical Systems

What Is Diagnostic Medical Systems's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Diagnostic Medical Systems had €13.4m of debt, an increase on €11.6m, over one year. However, it also had €3.83m in cash, and so its net debt is €9.62m.

How Healthy Is Diagnostic Medical Systems' Balance Sheet?

We can see from the most recent balance sheet that Diagnostic Medical Systems had liabilities of €21.7m falling due within a year, and liabilities of €11.1m due beyond that. On the other hand, it had cash of €3.83m and €11.2m worth of receivables due within a year. So its liabilities total €17.8m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of €20.4m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But it is Diagnostic Medical Systems'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.

In the last year Diagnostic Medical Systems wasn't profitable at an EBIT level, but managed to grow its revenue by 6.3%, to €40m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Diagnostic Medical Systems had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable €3.8m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Surprisingly, we note that it actually reported positive free cash flow of €783k and a profit of €2.2m. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. 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. Be aware that Diagnostic Medical Systems is showing 4 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.