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Warren Buffett famously said, '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 SKF India Limited (NSE:SKFINDIA) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for SKF India
What Is SKF India's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 SKF India had ₹900.0m of debt, an increase on ₹850.0m, over one year. However, it does have ₹6.46b in cash offsetting this, leading to net cash of ₹5.56b.
A Look At SKF India's Liabilities
According to the last reported balance sheet, SKF India had liabilities of ₹5.67b due within 12 months, and liabilities of ₹323.7m due beyond 12 months. On the other hand, it had cash of ₹6.46b and ₹5.88b worth of receivables due within a year. So it can boast ₹6.34b more liquid assets than total liabilities.
This short term liquidity is a sign that SKF India could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that SKF India has more cash than debt is arguably a good indication that it can manage its debt safely.
The good news is that SKF India has increased its EBIT by 3.9% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine SKF India's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. SKF India may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, SKF India recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.