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. As with many other companies Next Science Limited (ASX:NXS) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Next Science

What Is Next Science's Debt?

The image below, which you can click on for greater detail, shows that at December 2024 Next Science had debt of US$1.81m, up from none in one year. On the flip side, it has US$1.67m in cash leading to net debt of about US$132.1k.

A Look At Next Science's Liabilities

Zooming in on the latest balance sheet data, we can see that Next Science had liabilities of US$3.22m due within 12 months and liabilities of US$2.55m due beyond that. Offsetting these obligations, it had cash of US$1.67m as well as receivables valued at US$3.34m due within 12 months. So its liabilities total US$762.3k more than the combination of its cash and short-term receivables.

Since publicly traded Next Science shares are worth a total of US$21.3m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Carrying virtually no net debt, Next Science has a very light debt load indeed. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Next Science can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Next Science wasn't profitable at an EBIT level, but managed to grow its revenue by 2.9%, to US$23m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Next Science had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable US$10m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$8.6m of cash over the last year. So suffice it to say we consider the stock very risky. 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. To that end, you should learn about the 4 warning signs we've spotted with Next Science (including 1 which is potentially serious) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.