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. We can see that SomnoMed Limited (ASX:SOM) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for SomnoMed

What Is SomnoMed's Debt?

As you can see below, SomnoMed had AU$2.34m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has AU$17.6m in cash, leading to a AU$15.2m net cash position. debt-equity-history-analysis

A Look At SomnoMed's Liabilities

The latest balance sheet data shows that SomnoMed had liabilities of AU$18.2m due within a year, and liabilities of AU$6.93m falling due after that. Offsetting this, it had AU$17.6m in cash and AU$10.7m in receivables that were due within 12 months. So it actually has AU$3.08m more liquid assets than total liabilities.

This surplus suggests that SomnoMed has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, SomnoMed boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine SomnoMed's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this freereport showing analyst profit forecasts.



In the last year SomnoMed wasn't profitable at an EBIT level, but managed to grow its revenue by 20%, to AU$66m. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is SomnoMed?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year SomnoMed had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of AU$6.0m and booked a AU$4.6m accounting loss. With only AU$15.2m on the balance sheet, it would appear that its going to need to raise capital again soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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  3 warning signs  we've spotted with SomnoMed .

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.