David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, IVD Medical Holding Limited (HKG:1931) does carry debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for IVD Medical Holding

How Much Debt Does IVD Medical Holding Carry?

As you can see below, at the end of June 2019, IVD Medical Holding had CN¥110.0m of debt, up from CN¥0.3 a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥419.0m in cash, so it actually has CN¥309.0m net cash.

How Healthy Is IVD Medical Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that IVD Medical Holding had liabilities of CN¥1.05b due within 12 months and liabilities of CN¥202.5m due beyond that. Offsetting this, it had CN¥419.0m in cash and CN¥270.5m in receivables that were due within 12 months. So its liabilities total CN¥566.9m more than the combination of its cash and short-term receivables.

Since publicly traded IVD Medical Holding shares are worth a total of CN¥3.72b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, IVD Medical Holding boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, IVD Medical Holding grew its EBIT by 231% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is IVD Medical Holding's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While IVD Medical Holding 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. Over the last three years, IVD Medical Holding recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

Although IVD Medical Holding's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥309.0m. And it impressed us with its EBIT growth of 231% over the last year. So we are not troubled with IVD Medical Holding's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of IVD Medical Holding's earnings per share history for free.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

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