These 4 Measures Indicate That IVD Medical Holding (HKG:1931) Is Using Debt Reasonably Well

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.' 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 IVD Medical Holding Limited (HKG:1931) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for IVD Medical Holding

What Is IVD Medical Holding's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 IVD Medical Holding had debt of CN¥399.3m, up from CN¥273.5m in one year. But it also has CN¥794.7m in cash to offset that, meaning it has CN¥395.4m net cash.

How Healthy Is IVD Medical Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that IVD Medical Holding had liabilities of CN¥691.0m due within 12 months and liabilities of CN¥356.8m due beyond that. Offsetting this, it had CN¥794.7m in cash and CN¥435.9m in receivables that were due within 12 months. So it can boast CN¥182.8m more liquid assets than total liabilities.

This short term liquidity is a sign that IVD Medical Holding could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that IVD Medical Holding has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, IVD Medical Holding's EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is IVD Medical Holding's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. IVD Medical Holding 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. During the last three years, IVD Medical Holding produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case IVD Medical Holding has CN¥395.4m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 79% of that EBIT to free cash flow, bringing in CN¥145m. So we are not troubled with IVD Medical Holding'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. We've identified 3 warning signs with IVD Medical Holding , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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