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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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. We can see that Ramco Systems Limited (NSE:RAMCOSYS) does use debt in its business. But is this debt a concern to shareholders?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Ramco Systems
What Is Ramco Systems's Debt?
As you can see below, at the end of March 2019, Ramco Systems had ₹820.0m of debt, up from ₹380.0m a year ago. Click the image for more detail. However, it does have ₹112.2m in cash offsetting this, leading to net debt of about ₹707.8m.
How Healthy Is Ramco Systems's Balance Sheet?
We can see from the most recent balance sheet that Ramco Systems had liabilities of ₹2.45b falling due within a year, and liabilities of ₹184.0m due beyond that. Offsetting these obligations, it had cash of ₹112.2m as well as receivables valued at ₹3.33b due within 12 months. So it can boast ₹807.0m more liquid assets than total liabilities.
This excess liquidity suggests that Ramco Systems is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders.
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).