Is Elecon Engineering (NSE:ELECON) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Elecon Engineering Company Limited (NSE:ELECON) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Elecon Engineering

How Much Debt Does Elecon Engineering Carry?

As you can see below, at the end of March 2024, Elecon Engineering had ₹704.6m of debt, up from ₹515.8m a year ago. Click the image for more detail. However, its balance sheet shows it holds ₹4.78b in cash, so it actually has ₹4.08b net cash.

How Strong Is Elecon Engineering's Balance Sheet?

According to the last reported balance sheet, Elecon Engineering had liabilities of ₹3.99b due within 12 months, and liabilities of ₹1.21b due beyond 12 months. Offsetting this, it had ₹4.78b in cash and ₹4.55b in receivables that were due within 12 months. So it actually has ₹4.13b 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. Simply put, the fact that Elecon Engineering has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Elecon Engineering has been able to increase its EBIT by 29% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 84% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Elecon Engineering has net cash of ₹4.08b, as well as more liquid assets than liabilities. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in ₹3.3b. So we don't think Elecon Engineering's use of debt is risky. 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. For example - Elecon Engineering has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.