The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Sequent Scientific Limited (NSE:SEQUENT) does carry debt. But should shareholders be worried about its use of debt?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sequent Scientific

How Much Debt Does Sequent Scientific Carry?

The image below, which you can click on for greater detail, shows that Sequent Scientific had debt of ₹2.61b at the end of March 2019, a reduction from ₹3.11b over a year. However, because it has a cash reserve of ₹725.1m, its net debt is less, at about ₹1.88b.

How Healthy Is Sequent Scientific's Balance Sheet?

According to the last reported balance sheet, Sequent Scientific had liabilities of ₹4.33b due within 12 months, and liabilities of ₹2.08b due beyond 12 months. On the other hand, it had cash of ₹725.1m and ₹2.81b worth of receivables due within a year. So it has liabilities totalling ₹2.87b more than its cash and near-term receivables, combined.

Of course, Sequent Scientific has a market capitalization of ₹17.2b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). 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).