Here's Why Force Motors (NSE:FORCEMOT) Can Afford Some Debt

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.' 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. As with many other companies Force Motors Limited (NSE:FORCEMOT) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Force Motors

What Is Force Motors's Net Debt?

As you can see below, Force Motors had ₹2.35b of debt at March 2020, down from ₹2.57b a year prior. However, it also had ₹2.14b in cash, and so its net debt is ₹207.6m.

How Healthy Is Force Motors's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Force Motors had liabilities of ₹9.11b due within 12 months and liabilities of ₹2.20b due beyond that. Offsetting this, it had ₹2.14b in cash and ₹1.71b in receivables that were due within 12 months. So it has liabilities totalling ₹7.5b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Force Motors is worth ₹14.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. But either way, Force Motors has virtually no net debt, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Force Motors will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Force Motors made a loss at the EBIT level, and saw its revenue drop to ₹25b, which is a fall of 31%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Force Motors's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost ₹398.2m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled ₹491.6m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Force Motors (including 1 which is can't be ignored) .

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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