Like money can make the world go round, spiel can make stocks go up. A few days ago, market giant Reliance Industries said it had gone “net debt free” ahead of schedule. The action, already on fire thanks to mega deals selling stakes in the Jio platforms, reached the stratosphere during the announcement.
Lawyers revel in legal jargon, engineers are technical, and doctors speak medical jargon. Financial professionals, that rarefied race whose moolah makes the world go round, would they be left behind? So there is the world of financial jargon and in it there is something like net debt.
Simply put, net debt is borrowings less cash. So if a business has debt of 100 and cash flow of 40, its net debt would be 60 (100 minus 40). Debt includes short and long term borrowings, while cash here includes marketable investments that can be converted into cash quickly. Net debt tells us whether a business has the money to pay off all of its debt, if it becomes due immediately.
Be careful – “net debt” is not the same as “debt”. The prefix “net” before “debt” is crucial. So when a business declares that it is net debt free, it does not mean that it has paid off all of its loans. The debt is there until it is actually paid off. Certainly, a business can be net debt free even without repaying its debts; all he has to do is keep the cash equal to the debt.
For example, in the case of Reliance Industries, its net debt in March 2020 was 1.61 lakh crore (overdue debt of 3.36 lakh minus cash and cash equivalents of 1.75 lakh crore). Now, the company claims that with its recent fundraising of 1.69 lakh crore (1.16 lakh crore from the Jio agreements and 53,000 crore from the rights issue), it has become net debt free. Indeed, with these agreements, cash and equivalents would amount to 3.44 lakh crore, against an outstanding debt of 3.36 lakh crore.
Good, but the claim is not hole-proof. First, the Jio deals have been made, but has the money already arrived? In addition, only a quarter of the proceeds from the rights issue has been received to date. Should chickens be counted before they hatch?
Also, even if everything goes according to plan, “net zero debt” might reflect the picture better than “no net debt”. But hey, what’s the use of jargon if it doesn’t leave some leeway?
Net debt is an important measure in assessing the actual financial position of an entity. Usually, the lower the net debt, the better. But the number must be seen in the context of the industry in which the company operates and the stage of growth of the entity. Young companies strapped for equity may have to rely more on debt. In addition, net debt should be read along with other metrics such as debt to equity ratio and debt service coverage ratio.
That said, lower net debt could be an indicator of a company’s strength and sustainability. Especially in the present day of Covid, where to live to tell the story may well depend on the strength of the balance sheet.
You wouldn’t want to bet on a company that is groaning under an albatross of debt, right? The net debt count could help you identify solid stocks to invest in. You can also apply the concept to assess and improve your personal financial situation. Say you have 10 lakh loans and ₹ 1 lakh cash and equivalents. If you are not comfortable with your ₹ 9 lakh net debt, you may want to reduce it to avoid encountering unexpected problems.
Net-net, less net debt is a good bet.
A weekly column that makes learning fun