The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Abiomed, Inc. (NASDAQ:ABMD) makes use of debt. 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. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Abiomed

How Much Debt Does Abiomed Carry?

As you can see below, at the end of September 2021, Abiomed had US$2.77m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has US$650.6m in cash, leading to a US$647.8m net cash position.

How Healthy Is Abiomed's Balance Sheet?

The latest balance sheet data shows that Abiomed had liabilities of US$114.0m due within a year, and liabilities of US$31.4m falling due after that. Offsetting this, it had US$650.6m in cash and US$89.6m in receivables that were due within 12 months. So it actually has US$594.7m more liquid assets than total liabilities.

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

Also good is that Abiomed grew its EBIT at 17% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Abiomed 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Abiomed 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. During the last three years, Abiomed generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Abiomed has US$647.8m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 98% of that EBIT to free cash flow, bringing in US$233m. So is Abiomed's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 4 warning signs we've spotted with Abiomed .

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.