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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Paramount Communications Limited (NSE:PARACABLES) does use debt in its business. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Paramount Communications
What Is Paramount Communications's Debt?
The chart below, which you can click on for greater detail, shows that Paramount Communications had ₹1.97b in debt in March 2019; about the same as the year before. However, because it has a cash reserve of ₹155.8m, its net debt is less, at about ₹1.82b.
How Strong Is Paramount Communications's Balance Sheet?
According to the last reported balance sheet, Paramount Communications had liabilities of ₹1.29b due within 12 months, and liabilities of ₹1.99b due beyond 12 months. Offsetting these obligations, it had cash of ₹155.8m as well as receivables valued at ₹2.15b due within 12 months. So its liabilities total ₹969.4m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Paramount Communications is worth ₹1.63b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.