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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Elgi Equipments Limited (NSE:ELGIEQUIP) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Elgi Equipments

What Is Elgi Equipments's Net Debt?

As you can see below, Elgi Equipments had ₹5.51b of debt at September 2023, down from ₹6.06b a year prior. However, its balance sheet shows it holds ₹6.31b in cash, so it actually has ₹805.6m net cash.

How Healthy Is Elgi Equipments' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Elgi Equipments had liabilities of ₹10.5b due within 12 months and liabilities of ₹1.05b due beyond that. Offsetting these obligations, it had cash of ₹6.31b as well as receivables valued at ₹5.60b due within 12 months. So it can boast ₹349.8m more liquid assets than total liabilities.

Having regard to Elgi Equipments' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹169.9b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Elgi Equipments boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Elgi Equipments grew its EBIT by 35% 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 future earnings, more than anything, that will determine Elgi Equipments'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, while the tax-man may adore accounting profits, lenders only accept 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. In the last three years, Elgi Equipments's free cash flow amounted to 33% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Elgi Equipments has net cash of ₹805.6m, as well as more liquid assets than liabilities. And we liked the look of last year's 35% year-on-year EBIT growth. So is Elgi Equipments's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Elgi Equipments 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.