Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, B.O.S. Better Online Solutions Ltd. (NASDAQ:BOSC) does carry debt. But the real question is whether this debt is making the company risky.
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does B.O.S. Better Online Solutions Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 B.O.S. Better Online Solutions had US$2.91m of debt, an increase on US$2.64m, over one year. However, it does have US$1.44m in cash offsetting this, leading to net debt of about US$1.48m.
How Healthy Is B.O.S. Better Online Solutions's Balance Sheet?
The latest balance sheet data shows that B.O.S. Better Online Solutions had liabilities of US$8.61m due within a year, and liabilities of US$3.01m falling due after that. Offsetting these obligations, it had cash of US$1.44m as well as receivables valued at US$10.6m due within 12 months. So it can boast US$453.0k more liquid assets than total liabilities.
This surplus suggests that B.O.S. Better Online Solutions has a conservative balance sheet, and could probably eliminate its debt without much difficulty.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Looking at its net debt to EBITDA of 1.1 and interest cover of 5.1 times, it seems to us that B.O.S. Better Online Solutions is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Unfortunately, B.O.S. Better Online Solutions's EBIT flopped 11% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. There's no doubt that we learn most about debt from the balance sheet. But it is B.O.S. Better Online Solutions's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, B.O.S. Better Online Solutions burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
B.O.S. Better Online Solutions's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its level of total liabilities is relatively strong. Taking the abovementioned factors together we do think B.O.S. Better Online Solutions's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 B.O.S. Better Online Solutions's earnings per share history for free.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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