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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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Eifelhöhen-Klinik AG (FRA:EIF) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Eifelhöhen-Klinik
What Is Eifelhöhen-Klinik's Net Debt?
As you can see below, Eifelhöhen-Klinik had €22.1m of debt at December 2018, down from €25.3m a year prior. On the flip side, it has €10.2m in cash leading to net debt of about €11.9m.
How Healthy Is Eifelhöhen-Klinik's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Eifelhöhen-Klinik had liabilities of €9.03m due within 12 months and liabilities of €30.5m due beyond that. Offsetting these obligations, it had cash of €10.2m as well as receivables valued at €7.00m due within 12 months. So it has liabilities totalling €22.4m more than its cash and near-term receivables, combined.
This deficit casts a shadow over the €11.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt After all, Eifelhöhen-Klinik would likely require a major re-capitalisation if it had to pay its creditors today.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).