These 4 Measures Indicate That Dynamic Services & Security (NSE:DYNAMIC) Is Using Debt Reasonably Well

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.' 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. We note that Dynamic Services & Security Limited (NSE:DYNAMIC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Dynamic Services & Security

What Is Dynamic Services & Security's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Dynamic Services & Security had debt of ₹1.05b, up from ₹229.6m in one year. However, because it has a cash reserve of ₹472.2m, its net debt is less, at about ₹575.3m.

How Strong Is Dynamic Services & Security's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dynamic Services & Security had liabilities of ₹1.17b due within 12 months and liabilities of ₹57.7m due beyond that. Offsetting this, it had ₹472.2m in cash and ₹523.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹229.5m.

Given Dynamic Services & Security has a market capitalization of ₹4.50b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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 has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 5.3 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Dynamic Services & Security's EBIT launched higher than Elon Musk, gaining a whopping 106% 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Dynamic Services & Security burned a lot of cash. 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

Dynamic Services & Security's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. When we consider all the elements mentioned above, it seems to us that Dynamic Services & Security is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Dynamic Services & Security is showing 3 warning signs in our investment analysis , and 1 of those is concerning...

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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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.