These 4 Measures Indicate That SKF India (NSE:SKFINDIA) Is Using Debt Safely

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.' 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. Importantly, SKF India Limited (NSE:SKFINDIA) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 SKF India

What Is SKF India's Debt?

The image below, which you can click on for greater detail, shows that SKF India had debt of ₹175.8m at the end of March 2021, a reduction from ₹218.1m over a year. However, it does have ₹4.98b in cash offsetting this, leading to net cash of ₹4.80b.

A Look At SKF India's Liabilities

Zooming in on the latest balance sheet data, we can see that SKF India had liabilities of ₹6.93b due within 12 months and liabilities of ₹457.3m due beyond that. Offsetting this, it had ₹4.98b in cash and ₹6.15b in receivables that were due within 12 months. So it can boast ₹3.73b more liquid assets than total liabilities.

This short term liquidity is a sign that SKF India could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that SKF India has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, SKF India grew its EBIT by 154% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since SKF India will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. SKF India 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 most recent three years, SKF India recorded free cash flow worth 51% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that SKF India has net cash of ₹4.80b, as well as more liquid assets than liabilities. And we liked the look of last year's 154% year-on-year EBIT growth. So we don't think SKF India's use of debt is risky. 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. For instance, we've identified 2 warning signs for SKF India that 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.
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