Does Kewal Kiran Clothing (NSE:KKCL) Have A Healthy Balance Sheet?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Kewal Kiran Clothing Limited (NSE:KKCL) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Kewal Kiran Clothing

What Is Kewal Kiran Clothing's Debt?

As you can see below, Kewal Kiran Clothing had ₹831.3m of debt, at June 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has ₹2.32b in cash, leading to a ₹1.49b net cash position.

How Healthy Is Kewal Kiran Clothing's Balance Sheet?

The latest balance sheet data shows that Kewal Kiran Clothing had liabilities of ₹1.49b due within a year, and liabilities of ₹61.8m falling due after that. Offsetting this, it had ₹2.32b in cash and ₹1.30b in receivables that were due within 12 months. So it actually has ₹2.07b more liquid assets than total liabilities.

This excess liquidity suggests that Kewal Kiran Clothing is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Kewal Kiran Clothing has more cash than debt is arguably a good indication that it can manage its debt safely.

Importantly, Kewal Kiran Clothing's EBIT fell a jaw-dropping 53% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Kewal Kiran Clothing's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Kewal Kiran Clothing may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Kewal Kiran Clothing recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kewal Kiran Clothing has net cash of ₹1.49b, as well as more liquid assets than liabilities. So we don't have any problem with Kewal Kiran Clothing's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Kewal Kiran Clothing you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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