B.O.S. Better Online Solutions (NASDAQ:BOSC) Seems To Use Debt Quite Sensibly

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.' 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 B.O.S. Better Online Solutions Ltd. (NASDAQ:BOSC) makes use of debt. But the real question is whether this debt is making the company risky.

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 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.

View our latest analysis for B.O.S. Better Online Solutions

How Much Debt Does B.O.S. Better Online Solutions Carry?

As you can see below, at the end of September 2022, B.O.S. Better Online Solutions had US$2.37m of debt, up from US$1.58m a year ago. Click the image for more detail. On the flip side, it has US$1.21m in cash leading to net debt of about US$1.15m.

A Look At B.O.S. Better Online Solutions' Liabilities

We can see from the most recent balance sheet that B.O.S. Better Online Solutions had liabilities of US$10.1m falling due within a year, and liabilities of US$2.91m due beyond that. Offsetting this, it had US$1.21m in cash and US$11.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$263.0k.

Having regard to B.O.S. Better Online Solutions' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$14.7m company is struggling for cash, we still think it's worth monitoring its balance sheet.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Given net debt is only 0.76 times EBITDA, it is initially surprising to see that B.O.S. Better Online Solutions's EBIT has low interest coverage of 2.1 times. So one way or the other, it's clear the debt levels are not trivial. It is well worth noting that B.O.S. Better Online Solutions's EBIT shot up like bamboo after rain, gaining 56% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since B.O.S. Better Online Solutions 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Considering the last three years, B.O.S. Better Online Solutions actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

When it comes to the balance sheet, the standout positive for B.O.S. Better Online Solutions was the fact that it seems able to grow its EBIT confidently. But the other factors we noted above weren't so encouraging. To be specific, it seems about as good at covering its interest expense with its EBIT as wet socks are at keeping your feet warm. Considering this range of data points, we think B.O.S. Better Online Solutions is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for B.O.S. Better Online Solutions (of which 1 is concerning!) you should know about.

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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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.