Elecon Engineering (NSE:ELECON) Seems To Use Debt Rather Sparingly

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. As with many other companies Elecon Engineering Company Limited (NSE:ELECON) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Elecon Engineering

What Is Elecon Engineering's Net Debt?

As you can see below, Elecon Engineering had ₹454.8m of debt at September 2023, down from ₹568.8m a year prior. However, it does have ₹3.57b in cash offsetting this, leading to net cash of ₹3.11b.

How Healthy Is Elecon Engineering's Balance Sheet?

We can see from the most recent balance sheet that Elecon Engineering had liabilities of ₹3.75b falling due within a year, and liabilities of ₹911.1m due beyond that. Offsetting this, it had ₹3.57b in cash and ₹4.01b in receivables that were due within 12 months. So it can boast ₹2.91b more liquid assets than total liabilities.

This surplus suggests that Elecon Engineering has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Elecon Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Elecon Engineering has boosted its EBIT by 34%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Elecon Engineering's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Elecon Engineering may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Elecon Engineering generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Elecon Engineering has ₹3.11b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₹2.9b, being 87% of its EBIT. So is Elecon Engineering's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Elecon Engineering would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.