Greaves Cotton (NSE:GREAVESCOT) Has A Pretty Healthy Balance Sheet

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, Greaves Cotton Limited (NSE:GREAVESCOT) does carry debt. But should shareholders be worried about its use of debt?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Greaves Cotton

What Is Greaves Cotton's Debt?

The image below, which you can click on for greater detail, shows that Greaves Cotton had debt of ₹282.6m at the end of March 2023, a reduction from ₹2.57b over a year. However, it does have ₹6.50b in cash offsetting this, leading to net cash of ₹6.22b.

How Strong Is Greaves Cotton's Balance Sheet?

We can see from the most recent balance sheet that Greaves Cotton had liabilities of ₹7.13b falling due within a year, and liabilities of ₹438.8m due beyond that. On the other hand, it had cash of ₹6.50b and ₹5.36b worth of receivables due within a year. So it can boast ₹4.29b more liquid assets than total liabilities.

This short term liquidity is a sign that Greaves Cotton could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Greaves Cotton boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Greaves Cotton has seen its EBIT plunge 13% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Greaves Cotton 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Greaves Cotton 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. Over the last three years, Greaves Cotton saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Greaves Cotton has ₹6.22b in net cash and a decent-looking balance sheet. So we don't have any problem with Greaves Cotton's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Greaves Cotton that you should be aware of.

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.