These 4 Measures Indicate That Elgi Equipments (NSE:ELGIEQUIP) Is Using Debt Safely

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 note that Elgi Equipments Limited (NSE:ELGIEQUIP) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Elgi Equipments

What Is Elgi Equipments's Debt?

As you can see below, at the end of March 2023, Elgi Equipments had ₹5.09b of debt, up from ₹3.72b a year ago. Click the image for more detail. But it also has ₹5.70b in cash to offset that, meaning it has ₹615.1m net cash.

A Look At Elgi Equipments' Liabilities

Zooming in on the latest balance sheet data, we can see that Elgi Equipments had liabilities of ₹10.2b due within 12 months and liabilities of ₹1.09b due beyond that. On the other hand, it had cash of ₹5.70b and ₹5.55b worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Elgi Equipments' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₹168.0b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Elgi Equipments also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Elgi Equipments has boosted its EBIT by 60%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Elgi Equipments 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Elgi Equipments 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. Looking at the most recent three years, Elgi Equipments recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Elgi Equipments has ₹615.1m in net cash. And it impressed us with its EBIT growth of 60% over the last year. So we don't think Elgi Equipments's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Elgi Equipments (1 doesn't sit too well with us!) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.