Does Sharps Compliance (NASDAQ:SMED) Have A Healthy Balance Sheet?

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. We note that Sharps Compliance Corp. (NASDAQ:SMED) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sharps Compliance

How Much Debt Does Sharps Compliance Carry?

The image below, which you can click on for greater detail, shows that at March 2020 Sharps Compliance had debt of US$2.37m, up from US$1.59m in one year. However, it does have US$4.90m in cash offsetting this, leading to net cash of US$2.53m.

How Strong Is Sharps Compliance's Balance Sheet?

We can see from the most recent balance sheet that Sharps Compliance had liabilities of US$11.4m falling due within a year, and liabilities of US$9.70m due beyond that. Offsetting this, it had US$4.90m in cash and US$9.62m in receivables that were due within 12 months. So its liabilities total US$6.5m more than the combination of its cash and short-term receivables.

Given Sharps Compliance has a market capitalization of US$118.6m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Sharps Compliance also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Sharps Compliance made a loss at the EBIT level, last year, it was also good to see that it generated US$827k in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Sharps Compliance's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sharps Compliance 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. Over the last year, Sharps Compliance saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

We could understand if investors are concerned about Sharps Compliance's liabilities, but we can be reassured by the fact it has has net cash of US$2.53m. So we don't have any problem with Sharps Compliance's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Sharps Compliance insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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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