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. Importantly, Event Hospitality & Entertainment Limited (ASX:EVT) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Event Hospitality & Entertainment

What Is Event Hospitality & Entertainment's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2018 Event Hospitality & Entertainment had AU$420.1m of debt, an increase on AU$375.4m, over one year. However, because it has a cash reserve of AU$78.1m, its net debt is less, at about AU$342.0m.

A Look At Event Hospitality & Entertainment's Liabilities

Zooming in on the latest balance sheet data, we can see that Event Hospitality & Entertainment had liabilities of AU$255.0m due within 12 months and liabilities of AU$455.1m due beyond that. Offsetting these obligations, it had cash of AU$78.1m as well as receivables valued at AU$64.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$568.0m.

Event Hospitality & Entertainment has a market capitalization of AU$1.94b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).