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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Double Medical Technology Inc. (SZSE:002901) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Double Medical Technology Carry?

You can click the graphic below for the historical numbers, but it shows that Double Medical Technology had CN¥363.7m of debt in September 2024, down from CN¥465.3m, one year before. However, its balance sheet shows it holds CN¥1.26b in cash, so it actually has CN¥899.4m net cash.

A Look At Double Medical Technology's Liabilities

We can see from the most recent balance sheet that Double Medical Technology had liabilities of CN¥913.0m falling due within a year, and liabilities of CN¥289.4m due beyond that. Offsetting this, it had CN¥1.26b in cash and CN¥277.5m in receivables that were due within 12 months. So it actually has CN¥338.2m more liquid assets than total liabilities.

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

Although Double Medical Technology made a loss at the EBIT level, last year, it was also good to see that it generated CN¥174m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Double Medical Technology'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Double Medical Technology 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, Double Medical Technology 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

While we empathize with investors who find debt concerning, you should keep in mind that Double Medical Technology has net cash of CN¥899.4m, as well as more liquid assets than liabilities. So we are not troubled with Double Medical Technology's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Double Medical Technology is showing 2 warning signs in our investment analysis , you should know about...

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.