Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Contec Medical Systems Co.,Ltd (SZSE:300869) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

What Is Contec Medical SystemsLtd's Net Debt?

As you can see below, Contec Medical SystemsLtd had CN¥940.6m of debt at March 2024, down from CN¥1.36b a year prior. However, it does have CN¥1.63b in cash offsetting this, leading to net cash of CN¥693.3m.

A Look At Contec Medical SystemsLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Contec Medical SystemsLtd had liabilities of CN¥333.6m due within 12 months and liabilities of CN¥715.7m due beyond that. Offsetting this, it had CN¥1.63b in cash and CN¥60.3m in receivables that were due within 12 months. So it actually has CN¥644.9m more liquid assets than total liabilities.

This surplus suggests that Contec Medical SystemsLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Contec Medical SystemsLtd boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Contec Medical SystemsLtd'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.

Over 12 months, Contec Medical SystemsLtd made a loss at the EBIT level, and saw its revenue drop to CN¥477m, which is a fall of 47%. That makes us nervous, to say the least.

So How Risky Is Contec Medical SystemsLtd?

While Contec Medical SystemsLtd lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥66k. So taking that on face value, and considering the cash, we don't think its very risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Contec Medical SystemsLtd (2 are concerning) you should be aware of.

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.

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