Is Archos (EPA:ALJXR) Using Too Much Debt?

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. As with many other companies Archos S.A. (EPA:ALJXR) makes use of debt. But should shareholders be worried about its use of debt?

Our free stock report includes 4 warning signs investors should be aware of before investing in Archos. Read for free now.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

What Is Archos's Debt?

You can click the graphic below for the historical numbers, but it shows that Archos had €8.01m of debt in December 2024, down from €11.5m, one year before. However, it does have €10.2m in cash offsetting this, leading to net cash of €2.20m.

How Strong Is Archos' Balance Sheet?

The latest balance sheet data shows that Archos had liabilities of €8.96m due within a year, and liabilities of €10.6m falling due after that. On the other hand, it had cash of €10.2m and €5.46m worth of receivables due within a year. So it has liabilities totalling €3.85m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Archos is worth €12.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Archos also has more cash than debt, so we're pretty confident it can manage its debt safely.

View our latest analysis for Archos

We also note that Archos improved its EBIT from a last year's loss to a positive €1.1m. 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 Archos's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Archos 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. Over the last year, Archos recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While Archos does have more liabilities than liquid assets, it also has net cash of €2.20m. The cherry on top was that in converted 98% of that EBIT to free cash flow, bringing in €1.0m. So we are not troubled with Archos's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Archos (including 2 which are a bit concerning) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.