Is Sheela Foam (NSE:SFL) Using Too Much Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Sheela Foam Limited (NSE:SFL) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Sheela Foam

What Is Sheela Foam's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Sheela Foam had ₹5.71b of debt, an increase on ₹4.67b, over one year. But on the other hand it also has ₹7.54b in cash, leading to a ₹1.83b net cash position.

How Strong Is Sheela Foam's Balance Sheet?

We can see from the most recent balance sheet that Sheela Foam had liabilities of ₹6.83b falling due within a year, and liabilities of ₹4.19b due beyond that. On the other hand, it had cash of ₹7.54b and ₹2.83b worth of receivables due within a year. So its liabilities total ₹647.7m more than the combination of its cash and short-term receivables.

Having regard to Sheela Foam's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹106.3b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Sheela Foam also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Sheela Foam's EBIT dived 16%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sheela Foam's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Sheela Foam 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, Sheela Foam created free cash flow amounting to 17% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

We could understand if investors are concerned about Sheela Foam's liabilities, but we can be reassured by the fact it has has net cash of ₹1.83b. So we are not troubled with Sheela Foam's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Sheela Foam's earnings per share history for free.

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.