Is Chembio Diagnostics (NASDAQ:CEMI) Using Debt In A Risky Way?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Chembio Diagnostics, Inc. (NASDAQ:CEMI) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Chembio Diagnostics

What Is Chembio Diagnostics's Debt?

As you can see below, Chembio Diagnostics had US$18.6m of debt, at September 2021, which is about the same as the year before. You can click the chart for greater detail. But it also has US$36.0m in cash to offset that, meaning it has US$17.4m net cash.

How Strong Is Chembio Diagnostics' Balance Sheet?

According to the last reported balance sheet, Chembio Diagnostics had liabilities of US$11.4m due within 12 months, and liabilities of US$24.7m due beyond 12 months. Offsetting this, it had US$36.0m in cash and US$6.78m in receivables that were due within 12 months. So it actually has US$6.66m more liquid assets than total liabilities.

This surplus suggests that Chembio Diagnostics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Chembio Diagnostics has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Chembio 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.

In the last year Chembio Diagnostics wasn't profitable at an EBIT level, but managed to grow its revenue by 29%, to US$37m. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Chembio Diagnostics?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Chembio Diagnostics had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of US$31m and booked a US$27m accounting loss. With only US$17.4m on the balance sheet, it would appear that its going to need to raise capital again soon. With very solid revenue growth in the last year, Chembio Diagnostics may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 6 warning signs with Chembio Diagnostics (at least 2 which can't be ignored) , 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.

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.

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