Here's Why Vardhman Textiles (NSE:VTL) Can Manage Its Debt Responsibly

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. We note that Vardhman Textiles Limited (NSE:VTL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Vardhman Textiles

What Is Vardhman Textiles's Net Debt?

The image below, which you can click on for greater detail, shows that Vardhman Textiles had debt of ₹15.4b at the end of September 2022, a reduction from ₹17.1b over a year. But on the other hand it also has ₹16.8b in cash, leading to a ₹1.46b net cash position.

How Strong Is Vardhman Textiles' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Vardhman Textiles had liabilities of ₹15.1b due within 12 months and liabilities of ₹12.2b due beyond that. On the other hand, it had cash of ₹16.8b and ₹11.4b worth of receivables due within a year. So it can boast ₹927.5m more liquid assets than total liabilities.

This state of affairs indicates that Vardhman Textiles' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₹83.2b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Vardhman Textiles boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Vardhman Textiles if management cannot prevent a repeat of the 38% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Vardhman Textiles'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Vardhman Textiles 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, Vardhman Textiles's free cash flow amounted to 35% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Vardhman Textiles has ₹1.46b in net cash and a decent-looking balance sheet. So we don't have any problem with Vardhman Textiles's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Vardhman Textiles that you should be aware of before investing here.

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.