Precision Camshafts (NSE:PRECAM) Seems To Use Debt Quite Sensibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Precision Camshafts Limited (NSE:PRECAM) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt 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 ₹1.39b of debt in September 2021, down from ₹1.52b, one year before. However, it does have ₹2.94b in cash offsetting this, leading to net cash of ₹1.55b.

A Look At Precision Camshafts' Liabilities

We can see from the most recent balance sheet that Precision Camshafts had liabilities of ₹2.66b falling due within a year, and liabilities of ₹856.6m due beyond that. Offsetting these obligations, it had cash of ₹2.94b as well as receivables valued at ₹1.35b due within 12 months. So it can boast ₹771.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Precision Camshafts could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Precision Camshafts boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, Precision Camshafts made a loss at the EBIT level, last year, but improved that to positive EBIT of ₹136m in the last twelve months. 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 Precision Camshafts 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. Over the last year, Precision Camshafts actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Precision Camshafts has ₹1.55b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₹1.0b, being 738% of its EBIT. So is Precision Camshafts's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Precision Camshafts is showing 4 warning signs in our investment analysis , and 1 of those is concerning...

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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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.