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. We can see that Bridgeline Digital, Inc. (NASDAQ:BLIN) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.

What Is Bridgeline Digital’s Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Bridgeline Digital had debt of US$1.93m, up from US$88.0k in one year. But it also has US$8.85m in cash to offset that, meaning it has US$6.92m net cash.

A Look At Bridgeline Digital’s Liabilities

According to the last reported balance sheet, Bridgeline Digital had liabilities of US$8.34m due within 12 months, and liabilities of US$4.66m due beyond 12 months. Offsetting these obligations, it had cash of US$8.85m as well as receivables valued at US$1.37m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.78m.

Since publicly traded Bridgeline Digital shares are worth a total of US$24.2m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Bridgeline Digital boasts net cash, so it’s fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Bridgeline Digital can strengthen its balance sheet over time.

Over 12 months, Bridgeline Digital reported revenue of US$13m, which is a gain of 22%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

So How Risky Is Bridgeline Digital?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Bridgeline Digital had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of US$1.1m and booked a US$8.7m accounting loss. Given it only has net cash of US$6.92m, the company may need to raise more capital if it doesn’t reach break-even soon. Bridgeline Digital’s revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. 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.