Is Socket Mobile (NASDAQ:SCKT) Using Too Much 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. We can see that Socket Mobile, Inc. (NASDAQ:SCKT) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Socket Mobile

What Is Socket Mobile's Debt?

You can click the graphic below for the historical numbers, but it shows that Socket Mobile had US$2.09m of debt in September 2021, down from US$2.49m, one year before. But on the other hand it also has US$5.35m in cash, leading to a US$3.27m net cash position.

A Look At Socket Mobile's Liabilities

The latest balance sheet data shows that Socket Mobile had liabilities of US$5.08m due within a year, and liabilities of US$267.7k falling due after that. Offsetting this, it had US$5.35m in cash and US$2.70m in receivables that were due within 12 months. So it actually has US$2.71m more liquid assets than total liabilities.

This surplus suggests that Socket Mobile has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Socket Mobile boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Socket Mobile made a loss at the EBIT level, last year, it was also good to see that it generated US$2.5m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Socket Mobile'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Socket Mobile has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent year, Socket Mobile recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Socket Mobile has US$3.27m in net cash and a decent-looking balance sheet. So we are not troubled with Socket Mobile's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for Socket Mobile (of which 2 are significant!) you should know about.

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. 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.