Here's Why Balu Forge Industries (NSE:BALUFORGE) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 note that Balu Forge Industries Limited (NSE:BALUFORGE) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Balu Forge Industries

What Is Balu Forge Industries's Net Debt?

The image below, which you can click on for greater detail, shows that Balu Forge Industries had debt of ₹549.3m at the end of September 2024, a reduction from ₹704.3m over a year. But it also has ₹2.34b in cash to offset that, meaning it has ₹1.79b net cash.

How Healthy Is Balu Forge Industries' Balance Sheet?

We can see from the most recent balance sheet that Balu Forge Industries had liabilities of ₹1.72b falling due within a year, and liabilities of ₹249.4m due beyond that. On the other hand, it had cash of ₹2.34b and ₹2.60b worth of receivables due within a year. So it can boast ₹2.98b more liquid assets than total liabilities.

This surplus suggests that Balu Forge Industries has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Balu Forge Industries has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Balu Forge Industries grew its EBIT by 81% 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 ultimately the future profitability of the business will decide if Balu Forge Industries can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Balu Forge Industries has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Balu Forge Industries saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Balu Forge Industries has ₹1.79b in net cash and a decent-looking balance sheet. And we liked the look of last year's 81% year-on-year EBIT growth. So we are not troubled with Balu Forge Industries's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Balu Forge Industries (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.