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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 can see that Setco Automotive Limited (NSE:SETCO) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
View our latest analysis for Setco Automotive
How Much Debt Does Setco Automotive Carry?
The chart below, which you can click on for greater detail, shows that Setco Automotive had ₹3.93b in debt in March 2019; about the same as the year before. However, it does have ₹123.6m in cash offsetting this, leading to net debt of about ₹3.81b.
How Healthy Is Setco Automotive's Balance Sheet?
We can see from the most recent balance sheet that Setco Automotive had liabilities of ₹4.43b falling due within a year, and liabilities of ₹1.02b due beyond that. Offsetting this, it had ₹123.6m in cash and ₹1.08b in receivables that were due within 12 months. So it has liabilities totalling ₹4.24b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the ₹1.93b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt At the end of the day, Setco Automotive 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).