Does Nahar Spinning Mills (NSE:NAHARSPING) Have A 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. Importantly, Nahar Spinning Mills Limited (NSE:NAHARSPING) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Nahar Spinning Mills

How Much Debt Does Nahar Spinning Mills Carry?

You can click the graphic below for the historical numbers, but it shows that Nahar Spinning Mills had ₹4.36b of debt in September 2022, down from ₹8.11b, one year before. However, it also had ₹2.56b in cash, and so its net debt is ₹1.80b.

How Healthy Is Nahar Spinning Mills' Balance Sheet?

The latest balance sheet data shows that Nahar Spinning Mills had liabilities of ₹3.94b due within a year, and liabilities of ₹2.10b falling due after that. On the other hand, it had cash of ₹2.56b and ₹2.71b worth of receivables due within a year. So its liabilities total ₹769.6m more than the combination of its cash and short-term receivables.

Since publicly traded Nahar Spinning Mills shares are worth a total of ₹7.91b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Nahar Spinning Mills has a low net debt to EBITDA ratio of only 0.30. And its EBIT easily covers its interest expense, being 10.9 times the size. So we're pretty relaxed about its super-conservative use of debt. Fortunately, Nahar Spinning Mills grew its EBIT by 7.4% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is Nahar Spinning Mills'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last two years, Nahar Spinning Mills produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Nahar Spinning Mills's demonstrated ability handle its debt, based on its EBITDA, delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its interest cover is also very heartening. When we consider the range of factors above, it looks like Nahar Spinning Mills is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Nahar Spinning Mills 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.