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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Krishana Phoschem Limited (NSE:KRISHANA) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Krishana Phoschem
What Is Krishana Phoschem's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Krishana Phoschem had ₹393.9m of debt in March 2019, down from ₹419.1m, one year before. And it doesn't have much cash, so its net debt is about the same.
A Look At Krishana Phoschem's Liabilities
Zooming in on the latest balance sheet data, we can see that Krishana Phoschem had liabilities of ₹489.8m due within 12 months and liabilities of ₹168.0m due beyond that. Offsetting these obligations, it had cash of ₹447.0k as well as receivables valued at ₹343.8m due within 12 months. So its liabilities total ₹313.5m more than the combination of its cash and short-term receivables.
Krishana Phoschem has a market capitalization of ₹1.25b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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).
While Krishana Phoschem's low debt to EBITDA ratio of 1.3 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.8 last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Better yet, Krishana Phoschem grew its EBIT by 106% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Krishana Phoschem's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.