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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 note that Pricol Limited (NSE:PRICOLLTD) 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?
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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Pricol
What Is Pricol's Net Debt?
The image below, which you can click on for greater detail, shows that Pricol had debt of ₹2.79b at the end of March 2019, a reduction from ₹4.49b over a year. However, it does have ₹589.5m in cash offsetting this, leading to net debt of about ₹2.20b.
How Strong Is Pricol's Balance Sheet?
According to the last reported balance sheet, Pricol had liabilities of ₹9.33b due within 12 months, and liabilities of ₹1.65b due beyond 12 months. Offsetting these obligations, it had cash of ₹589.5m as well as receivables valued at ₹2.04b due within 12 months. So it has liabilities totalling ₹8.36b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the ₹3.32b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet." So we'd watch its balance sheet closely, without a doubt At the end of the day, Pricol would probably need a major re-capitalization if its creditors were to demand repayment.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).