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. As with many other companies AudioEye, Inc. (NASDAQ:AEYE) makes use of debt. But the more important question is: how much risk is that debt creating?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is AudioEye's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 AudioEye had debt of US$6.77m, up from none in one year. However, because it has a cash reserve of US$5.09m, its net debt is less, at about US$1.69m.

How Strong Is AudioEye's Balance Sheet?

According to the last reported balance sheet, AudioEye had liabilities of US$9.95m due within 12 months, and liabilities of US$7.20m due beyond 12 months. Offsetting these obligations, it had cash of US$5.09m as well as receivables valued at US$5.42m due within 12 months. So it has liabilities totalling US$6.64m more than its cash and near-term receivables, combined.

Of course, AudioEye has a market capitalization of US$233.1m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, AudioEye has a very light debt load indeed. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine AudioEye's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year AudioEye wasn't profitable at an EBIT level, but managed to grow its revenue by 3.9%, to US$32m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, AudioEye had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at US$2.4m. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$1.0m of cash over the last year. So to be blunt we think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for AudioEye (1 is significant) you should be aware of.

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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