David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Revolution Bars Group plc (LON:RBG) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Revolution Bars Group
What Is Revolution Bars Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2018 Revolution Bars Group had UK£18.5m of debt, an increase on UK£10.5m, over one year. However, it does have UK£3.66m in cash offsetting this, leading to net debt of about UK£14.8m.
How Strong Is Revolution Bars Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Revolution Bars Group had liabilities of UK£24.4m due within 12 months and liabilities of UK£31.8m due beyond that. On the other hand, it had cash of UK£3.66m and UK£10.1m worth of receivables due within a year. So its liabilities total UK£42.5m more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of UK£32.6m, we think shareholders really should watch Revolution Bars Group's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
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).