Does Shree Ram Proteins (NSE:SRPL) Have A Healthy Balance Sheet?

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. Importantly, Shree Ram Proteins Limited (NSE:SRPL) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Shree Ram Proteins

What Is Shree Ram Proteins's Net Debt?

The chart below, which you can click on for greater detail, shows that Shree Ram Proteins had ₹425.1m in debt in March 2022; about the same as the year before. On the flip side, it has ₹313.3m in cash leading to net debt of about ₹111.8m.

How Strong Is Shree Ram Proteins' Balance Sheet?

According to the last reported balance sheet, Shree Ram Proteins had liabilities of ₹530.6m due within 12 months, and liabilities of ₹107.6m due beyond 12 months. On the other hand, it had cash of ₹313.3m and ₹80.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹244.8m.

Given Shree Ram Proteins has a market capitalization of ₹2.64b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

While Shree Ram Proteins's low debt to EBITDA ratio of 0.87 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 2.7 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Pleasingly, Shree Ram Proteins is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 152% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Shree Ram Proteins's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Shree Ram Proteins actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Shree Ram Proteins's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its interest cover. Looking at the bigger picture, we think Shree Ram Proteins's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. To that end, you should be aware of the 3 warning signs we've spotted with Shree Ram Proteins .

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.