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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Saketh Exim Limited (NSE:SAKETH) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Saketh Exim

What Is Saketh Exim's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Saketh Exim had ₹99.6m of debt in March 2019, down from ₹199.3m, one year before. However, because it has a cash reserve of ₹14.6m, its net debt is less, at about ₹85.0m.

A Look At Saketh Exim's Liabilities

We can see from the most recent balance sheet that Saketh Exim had liabilities of ₹180.1m falling due within a year, and liabilities of ₹16.2m due beyond that. Offsetting these obligations, it had cash of ₹14.6m as well as receivables valued at ₹225.9m due within 12 months. So it can boast ₹44.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Saketh Exim 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Saketh Exim's net debt is sitting at a very reasonable 1.7 times its EBITDA, while its EBIT covered its interest expense just 3.0 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. If Saketh Exim can keep growing EBIT at last year's rate of 15% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But it is Saketh Exim'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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Saketh Exim reported free cash flow worth 7.1% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

We weren't impressed with Saketh Exim's interest cover, and its conversion of EBIT to free cash flow made us cautious. Balancing that a bit, it has a demonstrated ability EBIT growth rate. Considering this range of data points, we think Saketh Exim is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Over time, share prices tend to follow earnings per share, so if you're interested in Saketh Exim, you may well want to click here to check an interactive graph of its earnings per share history.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.