Dynamic Services & Security (NSE:DYNAMIC) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Dynamic Services & Security Limited (NSE:DYNAMIC) makes use of debt. 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Dynamic Services & Security

What Is Dynamic Services & Security's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Dynamic Services & Security had debt of ₹343.4m, up from ₹198.8m in one year. However, it also had ₹9.51m in cash, and so its net debt is ₹333.9m.

A Look At Dynamic Services & Security's Liabilities

Zooming in on the latest balance sheet data, we can see that Dynamic Services & Security had liabilities of ₹467.1m due within 12 months and liabilities of ₹50.1m due beyond that. On the other hand, it had cash of ₹9.51m and ₹351.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹156.1m.

Given Dynamic Services & Security has a market capitalization of ₹3.70b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Dynamic Services & Security's net debt is sitting at a very reasonable 1.9 times its EBITDA, while its EBIT covered its interest expense just 4.2 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Notably, Dynamic Services & Security's EBIT launched higher than Elon Musk, gaining a whopping 210% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is Dynamic Services & Security'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Dynamic Services & Security saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Based on what we've seen Dynamic Services & Security is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its EBIT growth rate. Looking at all this data makes us feel a little cautious about Dynamic Services & Security's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 Dynamic Services & Security is showing 4 warning signs in our investment analysis , and 2 of those are a bit unpleasant...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com