Here's Why BrainCool (NGM:BRAIN) Can Afford Some Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, BrainCool AB (publ) (NGM:BRAIN) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out the opportunities and risks within the SE Medical Equipment industry.

What Is BrainCool's Net Debt?

As you can see below, at the end of June 2022, BrainCool had kr40.0m of debt, up from none a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

A Look At BrainCool's Liabilities

According to the last reported balance sheet, BrainCool had liabilities of kr66.1m due within 12 months, and liabilities of kr10.0 due beyond 12 months. On the other hand, it had cash of kr700.5k and kr4.99m worth of receivables due within a year. So its liabilities total kr60.4m more than the combination of its cash and short-term receivables.

BrainCool has a market capitalization of kr111.3m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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 BrainCool will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year BrainCool wasn't profitable at an EBIT level, but managed to grow its revenue by 256%, to kr40m. When it comes to revenue growth, that's like nailing the game winning 3-pointer!

Caveat Emptor

While we can certainly appreciate BrainCool's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Its EBIT loss was a whopping kr40m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through kr40m of cash over the last year. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 5 warning signs for BrainCool you should be aware of, and 3 of them are significant.

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.