Health Check: How Prudently Does ReShape Lifesciences (NASDAQ:RSLS) Use Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies ReShape Lifesciences Inc. (NASDAQ:RSLS) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for ReShape Lifesciences

How Much Debt Does ReShape Lifesciences Carry?

The image below, which you can click on for greater detail, shows that ReShape Lifesciences had debt of US$2.97m at the end of September 2021, a reduction from US$9.76m over a year. But on the other hand it also has US$29.2m in cash, leading to a US$26.3m net cash position.

How Healthy Is ReShape Lifesciences' Balance Sheet?

We can see from the most recent balance sheet that ReShape Lifesciences had liabilities of US$10.3m falling due within a year, and liabilities of US$1.14m due beyond that. On the other hand, it had cash of US$29.2m and US$3.46m worth of receivables due within a year. So it can boast US$21.2m more liquid assets than total liabilities.

This surplus liquidity suggests that ReShape Lifesciences' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, ReShape Lifesciences boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine ReShape Lifesciences's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, ReShape Lifesciences reported revenue of US$14m, which is a gain of 13%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is ReShape Lifesciences?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months ReShape Lifesciences lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$14m and booked a US$35m accounting loss. Given it only has net cash of US$26.3m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for ReShape Lifesciences (1 can't be ignored) you should be aware of.

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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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.