We Think Elgi Equipments (NSE:ELGIEQUIP) Can Stay On Top Of Its Debt

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.' 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 Elgi Equipments Limited (NSE:ELGIEQUIP) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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?

The image below, which you can click on for greater detail, shows that Elgi Equipments had debt of ₹4.54b at the end of September 2024, a reduction from ₹5.51b over a year. However, its balance sheet shows it holds ₹6.43b in cash, so it actually has ₹1.90b 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 ₹9.75b due within 12 months and liabilities of ₹833.6m due beyond that. On the other hand, it had cash of ₹6.43b and ₹6.29b worth of receivables due within a year. So it actually has ₹2.14b 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 it's very unlikely that the ₹185.9b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Elgi Equipments has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Elgi Equipments has increased its EBIT by 9.0% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Elgi Equipments can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Elgi Equipments 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. In the last three years, Elgi Equipments's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Elgi Equipments has ₹1.90b in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 9.0% in the last twelve months. So we don't have any problem with Elgi Equipments's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Elgi Equipments's earnings per share history for free.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.