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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies SKF India Limited (NSE:SKFINDIA) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for SKF India

What Is SKF India's Net Debt?

You can click the graphic below for the historical numbers, but it shows that SKF India had ₹156.5m of debt in September 2022, down from ₹165.7m, one year before. However, its balance sheet shows it holds ₹6.63b in cash, so it actually has ₹6.48b net cash.

How Strong Is SKF India's Balance Sheet?

We can see from the most recent balance sheet that SKF India had liabilities of ₹7.39b falling due within a year, and liabilities of ₹487.3m due beyond that. Offsetting these obligations, it had cash of ₹6.63b as well as receivables valued at ₹7.30b due within 12 months. So it can boast ₹6.05b 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. Succinctly put, SKF India boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, SKF India grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. In the last three years, SKF India's free cash flow amounted to 41% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that SKF India has net cash of ₹6.48b, as well as more liquid assets than liabilities. And we liked the look of last year's 39% year-on-year EBIT growth. So is SKF India's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in SKF India, you may well want to click here to check an interactive graph of its earnings per share history.

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.