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.’ 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 Shriram Pistons & Rings Limited (NSE:SHRIPISTON) makes use of debt. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 Shriram Pistons & Rings
What Is Shriram Pistons & Rings’s Net Debt?
The image below, which you can click on for greater detail, shows that at September 2022 Shriram Pistons & Rings had debt of ₹2.44b, up from ₹1.27b in one year. But it also has ₹5.53b in cash to offset that, meaning it has ₹3.09b net cash.
How Healthy Is Shriram Pistons & Rings’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Shriram Pistons & Rings had liabilities of ₹5.65b due within 12 months and liabilities of ₹2.11b due beyond that. Offsetting this, it had ₹5.53b in cash and ₹4.01b in receivables that were due within 12 months. So it can boast ₹1.78b more liquid assets than total liabilities.
This short term liquidity is a sign that Shriram Pistons & Rings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shriram Pistons & Rings boasts net cash, so it’s fair to say it does not have a heavy debt load!
Also good is that Shriram Pistons & Rings grew its EBIT at 16% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can’t view debt in total isolation; since Shriram Pistons & Rings will need earnings to service that debt. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shriram Pistons & Rings 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. During the last three years, Shriram Pistons & Rings generated free cash flow amounting to a very robust 82% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Shriram Pistons & Rings has net cash of ₹3.09b, as well as more liquid assets than liabilities. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in ₹2.2b. So is Shriram Pistons & Rings’s debt a risk? It doesn’t seem so to us. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we’ve spotted with Shriram Pistons & Rings .
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.