Here's Why Siyaram Silk Mills (NSE:SIYSIL) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 can see that Siyaram Silk Mills Limited (NSE:SIYSIL) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Siyaram Silk Mills

How Much Debt Does Siyaram Silk Mills Carry?

You can click the graphic below for the historical numbers, but it shows that Siyaram Silk Mills had ₹1.63b of debt in March 2023, down from ₹2.23b, one year before. However, it does have ₹1.11b in cash offsetting this, leading to net debt of about ₹517.9m.

How Strong Is Siyaram Silk Mills' Balance Sheet?

The latest balance sheet data shows that Siyaram Silk Mills had liabilities of ₹4.14b due within a year, and liabilities of ₹857.6m falling due after that. Offsetting this, it had ₹1.11b in cash and ₹5.23b in receivables that were due within 12 months. So it can boast ₹1.34b more liquid assets than total liabilities.

This short term liquidity is a sign that Siyaram Silk Mills could probably pay off its debt with ease, as its balance sheet is far from stretched.

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.

Siyaram Silk Mills's net debt is only 0.15 times its EBITDA. And its EBIT easily covers its interest expense, being 52.6 times the size. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that Siyaram Silk Mills saw its EBIT decline by 4.7% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Siyaram Silk Mills can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Siyaram Silk Mills produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Siyaram Silk Mills's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its EBIT growth rate does undermine this impression a bit. When we consider the range of factors above, it looks like Siyaram Silk Mills is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Siyaram Silk Mills , and understanding them should be part of your investment process.

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.