These 4 Measures Indicate That Vardhman Textiles (NSE:VTL) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Vardhman Textiles Limited (NSE:VTL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Vardhman Textiles

What Is Vardhman Textiles's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Vardhman Textiles had debt of ₹17.1b, up from ₹15.9b in one year. However, it also had ₹14.5b in cash, and so its net debt is ₹2.66b.

How Strong Is Vardhman Textiles' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Vardhman Textiles had liabilities of ₹15.2b due within 12 months and liabilities of ₹12.2b due beyond that. Offsetting these obligations, it had cash of ₹14.5b as well as receivables valued at ₹12.5b due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Vardhman Textiles' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹128.9b company is struggling for cash, we still think it's worth monitoring its balance sheet.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Vardhman Textiles has a low net debt to EBITDA ratio of only 0.15. And its EBIT easily covers its interest expense, being 28.1 times the size. So we're pretty relaxed about its super-conservative use of debt. Better yet, Vardhman Textiles grew its EBIT by 521% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Vardhman Textiles created free cash flow amounting to 6.3% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Vardhman Textiles's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Zooming out, Vardhman Textiles seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. Be aware that Vardhman Textiles is showing 2 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.