Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Japara Healthcare Limited (ASX:JHC) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Japara Healthcare

How Much Debt Does Japara Healthcare Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2018 Japara Healthcare had AU$177.5m of debt, an increase on AU$86.0m, over one year. However, it does have AU$45.6m in cash offsetting this, leading to net debt of about AU$131.9m.

How Healthy Is Japara Healthcare's Balance Sheet?

According to the last reported balance sheet, Japara Healthcare had liabilities of AU$650.1m due within 12 months, and liabilities of AU$161.4m due beyond 12 months. Offsetting these obligations, it had cash of AU$45.6m as well as receivables valued at AU$15.5m due within 12 months. So it has liabilities totalling AU$750.3m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the AU$283.3m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Japara Healthcare would probably need a major re-capitalization if its creditors were to demand repayment.

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). 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).