Some say that volatility, not debt, is the best way to think about risk as an investor, but Warren Buffett once said, “Volatility is far from synonymous with risk.” When we think about how risky a company is, we always like to look at its level of debt, as excessive debt can lead to ruin. We can see that Cyient Limited (NSE:CYIENT) does indeed use debt in its business. But the real question is whether this debt makes the company risky.

When is debt dangerous?

Debt and other liabilities become risky for a company when it cannot easily meet those obligations, either through free cash flow or by raising capital at an attractive price. If the company cannot meet its legal obligations to repay the debt, shareholders could end up empty-handed. However, a more common (but still costly) case is that a company must issue shares at bargain prices, permanently diluting shareholders’ ownership, just to shore up its balance sheet. Of course, many companies use debt to finance growth without negative consequences. When we think about a company’s use of debt, we first consider cash and debt together.

Check out our latest analysis for Cyient

How much debt does Cyient have?

You can click on the chart below to see the historical numbers, but it shows that Cyient had ₹8.09 billion of debt as of March 2024, up from ₹12.2 billion a year earlier. However, the company also had ₹5.66 billion in cash, so its net debt is ₹2.43 billion.

How strong is Cyient’s balance sheet?

According to the last balance sheet, Cyient had liabilities of ₹16.6b due within 12 months and liabilities of ₹7.89b due beyond 12 months. This had ₹5.66b in cash and ₹17.4b in receivables due within 12 months. So liabilities exceed the combination of cash and (near-term) receivables by ₹1.45b.

Considering Cyient’s size, its cash and cash equivalents seem to be well-balanced with total liabilities, so it’s very unlikely that the Rs 197.8 billion company is short of cash, but it’s still worth keeping an eye on the balance sheet. But either way, Cyient has virtually no net debt, so it’s fair to say that the company doesn’t have a heavy debt burden!

To quantify 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 coverage ratio). The advantage of this approach is that we take into account both the absolute amount of debt (net debt relative to EBITDA) and the actual interest expense associated with that debt (its interest coverage ratio).

Cyient has a low net debt to EBITDA ratio of just 0.21. And its EBIT easily covers its interest expense, which is 16.3 times. So, you could argue that the company is no more threatened by its debt than an elephant is by a mouse. And we also take a positive note that Cyient was able to grow its EBIT by 15% over the last year, making its debt load more manageable. There’s no doubt that we learn the most about debt from the balance sheet. But it’s future earnings, more than anything, that will determine Cyient’s ability to maintain a healthy balance sheet going forward. So if you want to know what the professionals think, you might find this free report on analyst earnings forecasts interesting.

However, our final consideration is also important because a company cannot pay off debt with accounting profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is covered by actual free cash flow. Over the last three years, Cyient generated solid free cash flow, equal to 65% of its EBIT, which is about what we would expect. This free cash flow puts the company in a good position to pay down debt if needed.

Our view

The good news is that Cyient’s proven ability to cover its interest expenses with its EBIT makes us as happy as a fluffy puppy with a toddler. And that’s just the beginning of the good news, as its net debt to EBITDA ratio is also very encouraging. When you look closer, Cyient seems to be using debt quite sensibly; and that proves us right. While debt does bring risks, if used wisely, it can also deliver a higher return on equity. There’s no doubt that we learn the most about debt from the balance sheet. But ultimately, every company can contain risks that exist off the balance sheet. Keep in mind that Cyient shows 2 warning signals in our investment analysis you should know about…

If, after all that, you’re more interested in a fast-growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.