Olectra Greentech (NSE:OLECTRA) Seems To Use Debt Rather Sparingly

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 note that Olectra Greentech Limited (NSE:OLECTRA) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Olectra Greentech

How Much Debt Does Olectra Greentech Carry?

The image below, which you can click on for greater detail, shows that Olectra Greentech had debt of ₹145.3m at the end of September 2021, a reduction from ₹152.3m over a year. But it also has ₹1.01b in cash to offset that, meaning it has ₹863.5m net cash.

A Look At Olectra Greentech's Liabilities

We can see from the most recent balance sheet that Olectra Greentech had liabilities of ₹1.02b falling due within a year, and liabilities of ₹155.5m due beyond that. Offsetting this, it had ₹1.01b in cash and ₹2.68b in receivables that were due within 12 months. So it actually has ₹2.52b more liquid assets than total liabilities.

This short term liquidity is a sign that Olectra Greentech could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Olectra Greentech has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Olectra Greentech turned things around in the last 12 months, delivering and EBIT of ₹439m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Olectra Greentech's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Olectra Greentech 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. During the last year, Olectra Greentech produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Olectra Greentech has ₹863.5m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 74% of that EBIT to free cash flow, bringing in ₹325m. So is Olectra Greentech's debt a risk? It doesn't seem so to us. 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. Be aware that Olectra Greentech is showing 2 warning signs in our investment analysis , you should know about...

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.