Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Amoy Diagnostics Co., Ltd. (SZSE:300685) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Amoy Diagnostics Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Amoy Diagnostics had CN¥52.9m of debt, an increase on CN¥50.2m, over one year. However, it does have CN¥1.09b in cash offsetting this, leading to net cash of CN¥1.03b.

How Strong Is Amoy Diagnostics' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Amoy Diagnostics had liabilities of CN¥216.3m due within 12 months and liabilities of CN¥10.8m due beyond that. Offsetting these obligations, it had cash of CN¥1.09b as well as receivables valued at CN¥601.0m due within 12 months. So it actually has CN¥1.46b more liquid assets than total liabilities.

It's good to see that Amoy Diagnostics has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Amoy Diagnostics boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Amoy Diagnostics grew its EBIT by 67% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Amoy Diagnostics can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Amoy Diagnostics 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, Amoy Diagnostics generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Amoy Diagnostics has net cash of CN¥1.03b, as well as more liquid assets than liabilities. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in CN¥289m. The bottom line is that we do not find Amoy Diagnostics's debt levels at all concerning. 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 Amoy Diagnostics'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.

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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.