Equatorial Pará Distribuidora de Energia (BVMF:EQPA3) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Equatorial Pará Distribuidora de Energia S.A. (BVMF:EQPA3) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Equatorial Pará Distribuidora de Energia

How Much Debt Does Equatorial Pará Distribuidora de Energia Carry?

The chart below, which you can click on for greater detail, shows that Equatorial Pará Distribuidora de Energia had R$4.12b in debt in December 2021; about the same as the year before. However, because it has a cash reserve of R$1.55b, its net debt is less, at about R$2.57b.

A Look At Equatorial Pará Distribuidora de Energia's Liabilities

We can see from the most recent balance sheet that Equatorial Pará Distribuidora de Energia had liabilities of R$3.29b falling due within a year, and liabilities of R$5.48b due beyond that. Offsetting these obligations, it had cash of R$1.55b as well as receivables valued at R$2.82b due within 12 months. So its liabilities total R$4.40b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Equatorial Pará Distribuidora de Energia has a market capitalization of R$12.9b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up 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 cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 1.2 and interest cover of 5.2 times, it seems to us that Equatorial Pará Distribuidora de Energia is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, Equatorial Pará Distribuidora de Energia grew its EBIT by 31% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Equatorial Pará Distribuidora de Energia'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. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Equatorial Pará Distribuidora de Energia's free cash flow amounted to 36% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Equatorial Pará Distribuidora de Energia's impressive EBIT growth rate implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. It's also worth noting that Equatorial Pará Distribuidora de Energia is in the Electric Utilities industry, which is often considered to be quite defensive. Looking at all the aforementioned factors together, it strikes us that Equatorial Pará Distribuidora de Energia can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Equatorial Pará Distribuidora de Energia you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.