Does Sarla Performance Fibers (NSE:SARLAPOLY) Have A Healthy Balance Sheet?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Sarla Performance Fibers Limited (NSE:SARLAPOLY) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 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 Sarla Performance Fibers

What Is Sarla Performance Fibers's Net Debt?

As you can see below, at the end of September 2024, Sarla Performance Fibers had ₹1.42b of debt, up from ₹1.18b a year ago. Click the image for more detail. However, it does have ₹590.0m in cash offsetting this, leading to net debt of about ₹831.9m.

A Look At Sarla Performance Fibers' Liabilities

Zooming in on the latest balance sheet data, we can see that Sarla Performance Fibers had liabilities of ₹1.85b due within 12 months and liabilities of ₹580.0m due beyond that. Offsetting these obligations, it had cash of ₹590.0m as well as receivables valued at ₹955.5m due within 12 months. So it has liabilities totalling ₹884.5m more than its cash and near-term receivables, combined.

Of course, Sarla Performance Fibers has a market capitalization of ₹7.66b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Sarla Performance Fibers's net debt is only 0.99 times its EBITDA. And its EBIT covers its interest expense a whopping 22.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that Sarla Performance Fibers grew its EBIT by 187% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sarla Performance Fibers's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Sarla Performance Fibers generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Sarla Performance Fibers's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that Sarla Performance Fibers is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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. Case in point: We've spotted 2 warning signs for Sarla Performance Fibers you should be aware of.

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.