We Think SKF India (NSE:SKFINDIA) Can Manage Its Debt With Ease

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.' 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. We note that SKF India Limited (NSE:SKFINDIA) does have debt on its balance sheet. But is this debt a concern to shareholders?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for SKF India

What Is SKF India's Net Debt?

The image below, which you can click on for greater detail, shows that SKF India had debt of ₹165.7m at the end of September 2021, a reduction from ₹533.7m over a year. However, it does have ₹3.70b in cash offsetting this, leading to net cash of ₹3.53b.

A Look At SKF India's Liabilities

According to the last reported balance sheet, SKF India had liabilities of ₹7.05b due within 12 months, and liabilities of ₹489.6m due beyond 12 months. Offsetting these obligations, it had cash of ₹3.70b as well as receivables valued at ₹6.05b due within 12 months. So it actually has ₹2.21b more liquid assets than total liabilities.

Having regard to SKF India's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹177.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that SKF India has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, SKF India grew its EBIT by 70% 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 45% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case SKF India has ₹3.53b in net cash and a decent-looking balance sheet. And we liked the look of last year's 70% year-on-year EBIT growth. So is SKF India's debt a risk? It doesn't seem so to us. 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. Be aware that SKF India is showing 1 warning sign in our investment analysis , you should know about...

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.