Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Touchwood Entertainment Limited (NSE:TOUCHWOOD) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Touchwood Entertainment Carry?
You can click the graphic below for the historical numbers, but it shows that Touchwood Entertainment had ₹7.32m of debt in March 2019, down from ₹7.80m, one year before. But on the other hand it also has ₹38.7m in cash, leading to a ₹31.3m net cash position.
A Look At Touchwood Entertainment's Liabilities
According to the last reported balance sheet, Touchwood Entertainment had liabilities of ₹83.6m due within 12 months, and liabilities of ₹10.9m due beyond 12 months. Offsetting these obligations, it had cash of ₹38.7m as well as receivables valued at ₹84.8m due within 12 months. So it actually has ₹29.0m more liquid assets than total liabilities.
This surplus suggests that Touchwood Entertainment has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Touchwood Entertainment has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Touchwood Entertainment grew its EBIT by 61% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Touchwood Entertainment's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Touchwood Entertainment 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. During the last three years, Touchwood Entertainment burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While we empathize with investors who find debt concerning, you should keep in mind that Touchwood Entertainment has net cash of ₹31m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 61% over the last year. So we don't have any problem with Touchwood Entertainment's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Touchwood Entertainment, you may well want to click here to check an interactive graph of its earnings per share history.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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