Is Precision Camshafts (NSE:PRECAM) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Precision Camshafts Limited (NSE:PRECAM) makes use of debt. But is this debt a concern to shareholders?

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. 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.

View our latest analysis for Precision Camshafts

What Is Precision Camshafts's Net Debt?

The image below, which you can click on for greater detail, shows that Precision Camshafts had debt of ₹1.04b at the end of September 2024, a reduction from ₹1.11b over a year. But it also has ₹3.61b in cash to offset that, meaning it has ₹2.57b net cash.

How Healthy Is Precision Camshafts' Balance Sheet?

The latest balance sheet data shows that Precision Camshafts had liabilities of ₹2.21b due within a year, and liabilities of ₹417.6m falling due after that. Offsetting this, it had ₹3.61b in cash and ₹1.58b in receivables that were due within 12 months. So it actually has ₹2.57b more liquid assets than total liabilities.

It's good to see that Precision Camshafts has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Precision Camshafts has more cash than debt is arguably a good indication that it can manage its debt safely.

Shareholders should be aware that Precision Camshafts's EBIT was down 41% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. 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. While Precision Camshafts 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. Over the last three years, Precision Camshafts actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to investigate a company's debt, in this case Precision Camshafts has ₹2.57b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 263% of that EBIT to free cash flow, bringing in ₹846m. 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. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Precision Camshafts you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.