All you wanted to know about net debt

Anand Kalyanaraman | Updated on June 29, 2020

Like money can make the world go round, spiel can make stocks go up. A few day ago, market behemoth Reliance Industries declared that it had become ‘net debt free’ before schedule. The stock, already on fire thanks to mega stake sale deals in Jio Platforms, shot up to the stratosphere on this announcement.

What is it?

Lawyers revel in legalese, engineers have their technicalese, and doctors speak medicalese. Would finance professionals, that rarefied breed whose moolah keeps the world spinning, be left behind? So, there is the world of financial jargon and in it, there is such a thing as net debt.

Simply put, net debt is borrowings minus cash. So, if a business has debt of ₹100 and cash of ₹40, its net debt would be ₹60 (100 minus 40). Debt includes both short-term and long-term borrowings, while cash here includes marketable investments that can be converted to cash in quick time. Net debt tells us whether a business has the money to pay off all its debt, if it becomes due immediately.

Heads up — ‘net debt’ is not the same as ‘debt’. The prefix ‘net’ before ‘debt’ is crucial. So, when a business says it is net debt-free, that does not mean it has repaid all its borrowings. The debt is very much there until it is actually paid off. To be sure, a business can be net-debt free even without paying off debt; all it needs to do is to keep cash equal to debt.

For instance, in the case of Reliance Industries, its net debt as on March 2020 was ₹1.61-lakh crore (outstanding debt of ₹3.36-lakh crore minus cash and equivalents of ₹1.75-lakh crore). Now, the company says that with its recent fund raise of ₹1.69-lakh crore (₹1.16-lakh crore from the Jio deals and ₹53,000 crore from the rights issue), it has become net debt-free. Effectively, with these deals, cash and equivalents would rise to ₹3.44-lakh crore, against outstanding debt of ₹3.36 lakh crore.

Nice, but the claim is not hole-proof. One, the Jio deals have been struck, but has the cash come in already? Also, only a quarter of the rights issue proceeds has been received so far. Should one count the chickens before they hatch?

Besides, even if all goes to plan, ‘zero net-debt’ might convey the picture better than ‘net debt-free’. But hey, what’s the use of jargon if it doesn’t allow some latitude?

Why is it important?

Net debt is an important metric to fathom the actual financial position of an entity. Usually, the lower the net debt, the better. But the number should be seen in the context of the industry the business operates in and the stage of growth of the entity. Young businesses, starved of equity, may have to depend more on debt. Also, net debt should be read along with other metrics such as debt-to-equity and debt service coverage ratio.

That said, lower net debt could be an indicator of the strength and sustainability of a business. Especially in the current Covid-challenged times, when living to tell the tale may well depend on balance-sheet robustness.

Why should I care?

You wouldn’t want to bet on a company groaning under an albatross of debt, no? The net debt number could help you identify solid stocks to invest in. You can also apply the concept to assess and improve your personal finance situation. Say, you have loans of ₹10 lakh and cash and equivalents of ₹1 lakh. If you are not comfortable with your net debt of ₹9 lakh, you may want to lower it to avoid running into unexpected trouble.

The bottomline

Net-net, less net debt is a good bet.

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Published on June 30, 2020

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