Here's Why Precision Camshafts (NSE:PRECAM) Can Manage Its Debt Responsibly

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 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 note that Precision Camshafts Limited (NSE:PRECAM) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for Precision Camshafts

What Is Precision Camshafts's Debt?

You can click the graphic below for the historical numbers, but it shows that Precision Camshafts had ₹1.01b of debt in September 2023, down from ₹1.08b, one year before. However, its balance sheet shows it holds ₹2.73b in cash, so it actually has ₹1.72b net cash.

A Look At Precision Camshafts' Liabilities

According to the last reported balance sheet, Precision Camshafts had liabilities of ₹3.54b due within 12 months, and liabilities of ₹289.9m due beyond 12 months. On the other hand, it had cash of ₹2.73b and ₹1.92b worth of receivables due within a year. So it can boast ₹817.6m more liquid assets than total liabilities.

This surplus suggests that Precision Camshafts has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Precision Camshafts boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Precision Camshafts if management cannot prevent a repeat of the 21% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Precision Camshafts's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Precision Camshafts 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. Happily for any shareholders, Precision Camshafts actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Precision Camshafts has ₹1.72b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₹296m, being 200% of its EBIT. So we don't have any problem with Precision Camshafts's use of debt. 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. Case in point: We've spotted 1 warning sign for Precision Camshafts you should be aware of.

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.