Here's Why Precision Wires India (NSE:PRECWIRE) Can Manage Its Debt Responsibly

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. Importantly, Precision Wires India Ltd. (NSE:PRECWIRE) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Precision Wires India

What Is Precision Wires India's Net Debt?

As you can see below, Precision Wires India had ₹127.7m of debt at September 2020, down from ₹456.5m a year prior. However, it does have ₹462.6m in cash offsetting this, leading to net cash of ₹334.9m.

A Look At Precision Wires India's Liabilities

The latest balance sheet data shows that Precision Wires India had liabilities of ₹2.97b due within a year, and liabilities of ₹165.9m falling due after that. Offsetting these obligations, it had cash of ₹462.6m as well as receivables valued at ₹2.83b due within 12 months. So it actually has ₹159.4m more liquid assets than total liabilities.

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

Importantly, Precision Wires India's EBIT fell a jaw-dropping 41% in the last twelve months. 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 Wires India'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Precision Wires India 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. In the last three years, Precision Wires India's free cash flow amounted to 50% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Precision Wires India has ₹334.9m in net cash and a decent-looking balance sheet. So we don't have any problem with Precision Wires India'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 Wires India you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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