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Does Ideagen (LON:IDEA) Have A Healthy Balance Sheet?

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. 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, Ideagen plc (LON:IDEA) does carry debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

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See our latest analysis for Ideagen

What Is Ideagen's Debt?

The image below, which you can click on for greater detail, shows that at April 2019 Ideagen had debt of UK£7.50m, up from UK£4.75m in one year. On the flip side, it has UK£6.20m in cash leading to net debt of about UK£1.30m.

AIM:IDEA Historical Debt, October 31st 2019
AIM:IDEA Historical Debt, October 31st 2019

How Healthy Is Ideagen's Balance Sheet?

According to the last reported balance sheet, Ideagen had liabilities of UK£34.5m due within 12 months, and liabilities of UK£7.34m due beyond 12 months. Offsetting these obligations, it had cash of UK£6.20m as well as receivables valued at UK£14.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£21.0m.

Since publicly traded Ideagen shares are worth a total of UK£327.1m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Ideagen has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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).

Ideagen has a low net debt to EBITDA ratio of only 0.17. And its EBIT easily covers its interest expense, being 12.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Ideagen has boosted its EBIT by 68%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Ideagen can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Ideagen actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, Ideagen's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. We think Ideagen is no more beholden to its lenders, than the birds are to birdwatchers. For investing nerds like us its balance sheet is almost charming. 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 Ideagen'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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.