These 4 Measures Indicate That Lexibook - Linguistic Electronic System Société anonyme (EPA:ALLEX) Is Using Debt Extensively

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.' 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. We note that Lexibook - Linguistic Electronic System Société anonyme (EPA:ALLEX) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Lexibook - Linguistic Electronic System Société anonyme

How Much Debt Does Lexibook - Linguistic Electronic System Société anonyme Carry?

As you can see below, at the end of March 2023, Lexibook - Linguistic Electronic System Société anonyme had €8.85m of debt, up from €8.49m a year ago. Click the image for more detail. However, because it has a cash reserve of €2.44m, its net debt is less, at about €6.41m.

How Healthy Is Lexibook - Linguistic Electronic System Société anonyme's Balance Sheet?

The latest balance sheet data shows that Lexibook - Linguistic Electronic System Société anonyme had liabilities of €13.1m due within a year, and liabilities of €5.40m falling due after that. Offsetting this, it had €2.44m in cash and €5.83m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €10.2m.

While this might seem like a lot, it is not so bad since Lexibook - Linguistic Electronic System Société anonyme has a market capitalization of €20.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

With net debt sitting at just 1.3 times EBITDA, Lexibook - Linguistic Electronic System Société anonyme is arguably pretty conservatively geared. And it boasts interest cover of 9.2 times, which is more than adequate. Lexibook - Linguistic Electronic System Société anonyme's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Lexibook - Linguistic Electronic System Société anonyme will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Lexibook - Linguistic Electronic System Société anonyme recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Lexibook - Linguistic Electronic System Société anonyme's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to to cover its interest expense with its EBIT isn't too shabby at all. When we consider all the factors discussed, it seems to us that Lexibook - Linguistic Electronic System Société anonyme is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. Be aware that Lexibook - Linguistic Electronic System Société anonyme is showing 2 warning signs in our investment analysis , you should know about...

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.