Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, RXP Services Limited (ASX:RXP) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

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How Much Debt Does RXP Services Carry?

The image below, which you can click on for greater detail, shows that at June 2019 RXP Services had debt of AU$22.0m, up from AU$13.0m in one year. However, it does have AU$11.7m in cash offsetting this, leading to net debt of about AU$10.3m.

A Look At RXP Services's Liabilities

According to the last reported balance sheet, RXP Services had liabilities of AU$30.8m due within 12 months, and liabilities of AU$22.6m due beyond 12 months. Offsetting this, it had AU$11.7m in cash and AU$38.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$3.38m.

Of course, RXP Services has a market capitalization of AU$86.2m, 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.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

RXP Services has a low net debt to EBITDA ratio of only 0.62. And its EBIT covers its interest expense a whopping 19.7 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, RXP Services grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if RXP Services can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.