Does Kajaria Ceramics (NSE:KAJARIACER) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Kajaria Ceramics Limited (NSE:KAJARIACER) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Kajaria Ceramics

What Is Kajaria Ceramics's Debt?

As you can see below, Kajaria Ceramics had ₹1.25b of debt at September 2023, down from ₹1.87b a year prior. However, its balance sheet shows it holds ₹5.17b in cash, so it actually has ₹3.92b net cash.

How Strong Is Kajaria Ceramics' Balance Sheet?

According to the last reported balance sheet, Kajaria Ceramics had liabilities of ₹6.53b due within 12 months, and liabilities of ₹1.89b due beyond 12 months. On the other hand, it had cash of ₹5.17b and ₹5.69b worth of receivables due within a year. So it actually has ₹2.45b more liquid assets than total liabilities.

Having regard to Kajaria Ceramics' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹215.8b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Kajaria Ceramics boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Kajaria Ceramics grew its EBIT by 3.6% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kajaria Ceramics'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Kajaria Ceramics 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, Kajaria Ceramics recorded free cash flow of 36% 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 investigate a company's debt, in this case Kajaria Ceramics has ₹3.92b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 3.6% over the last year. So we don't have any problem with Kajaria Ceramics's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Kajaria Ceramics that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.