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. As with many other companies Jakharia Fabric Limited (NSE:JAKHARIA) makes use of debt. But is this debt a concern to shareholders?
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Jakharia Fabric
What Is Jakharia Fabric's Net Debt?
As you can see below, Jakharia Fabric had ₹226.5m of debt, at March 2019, which is about the same the year before. You can click the chart for greater detail. However, it also had ₹7.51m in cash, and so its net debt is ₹219.0m.
How Strong Is Jakharia Fabric's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Jakharia Fabric had liabilities of ₹210.5m due within 12 months and liabilities of ₹211.1m due beyond that. On the other hand, it had cash of ₹7.51m and ₹177.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹236.5m.
While this might seem like a lot, it is not so bad since Jakharia Fabric has a market capitalization of ₹745.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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).