Does L.G. Balakrishnan & Bros (NSE:LGBBROSLTD) 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 L.G. Balakrishnan & Bros Limited (NSE:LGBBROSLTD) 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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for L.G. Balakrishnan & Bros

What Is L.G. Balakrishnan & Bros's Debt?

As you can see below, L.G. Balakrishnan & Bros had ₹1.12b of debt at September 2020, down from ₹2.18b a year prior. But on the other hand it also has ₹1.50b in cash, leading to a ₹381.2m net cash position.

How Strong Is L.G. Balakrishnan & Bros's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that L.G. Balakrishnan & Bros had liabilities of ₹3.60b due within 12 months and liabilities of ₹1.10b due beyond that. Offsetting this, it had ₹1.50b in cash and ₹2.02b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.17b.

Given L.G. Balakrishnan & Bros has a market capitalization of ₹8.68b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, L.G. Balakrishnan & Bros boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that L.G. Balakrishnan & Bros's load is not too heavy, because its EBIT was down 36% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if L.G. Balakrishnan & Bros 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 company can only pay off debt with cold hard cash, not accounting profits. L.G. Balakrishnan & Bros 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, L.G. Balakrishnan & Bros recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While L.G. Balakrishnan & Bros does have more liabilities than liquid assets, it also has net cash of ₹381.2m. So while L.G. Balakrishnan & Bros does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for L.G. Balakrishnan & Bros you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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