RWS Holdings (LON:RWS) Seems To Use Debt Rather Sparingly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that RWS Holdings plc (LON:RWS) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for RWS Holdings

How Much Debt Does RWS Holdings Carry?

The image below, which you can click on for greater detail, shows that RWS Holdings had debt of UK£42.4m at the end of March 2022, a reduction from UK£50.4m over a year. However, its balance sheet shows it holds UK£80.6m in cash, so it actually has UK£38.2m net cash.

A Look At RWS Holdings' Liabilities

According to the last reported balance sheet, RWS Holdings had liabilities of UK£193.4m due within 12 months, and liabilities of UK£142.5m due beyond 12 months. Offsetting this, it had UK£80.6m in cash and UK£195.9m in receivables that were due within 12 months. So it has liabilities totalling UK£59.4m more than its cash and near-term receivables, combined.

Since publicly traded RWS Holdings shares are worth a total of UK£1.31b, 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, RWS Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, RWS Holdings grew its EBIT by 114% last year, which is an impressive improvement. That boost will make it even 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 RWS Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While RWS Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, RWS Holdings actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

We could understand if investors are concerned about RWS Holdings's liabilities, but we can be reassured by the fact it has has net cash of UK£38.2m. The cherry on top was that in converted 115% of that EBIT to free cash flow, bringing in UK£102m. So is RWS Holdings's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in RWS Holdings would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.