Is Revathi Equipment (NSE:REVATHI) A Risky Investment?

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. Importantly, Revathi Equipment Limited (NSE:REVATHI) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out the opportunities and risks within the IN Machinery industry.

What Is Revathi Equipment's Net Debt?

The image below, which you can click on for greater detail, shows that Revathi Equipment had debt of ₹309.9m at the end of September 2022, a reduction from ₹498.0m over a year. But on the other hand it also has ₹779.3m in cash, leading to a ₹469.4m net cash position.

A Look At Revathi Equipment's Liabilities

The latest balance sheet data shows that Revathi Equipment had liabilities of ₹1.57b due within a year, and liabilities of ₹159.5m falling due after that. Offsetting this, it had ₹779.3m in cash and ₹744.7m in receivables that were due within 12 months. So its liabilities total ₹208.4m more than the combination of its cash and short-term receivables.

Since publicly traded Revathi Equipment shares are worth a total of ₹3.60b, it seems unlikely that this level of liabilities would be a major 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, Revathi Equipment boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Revathi Equipment grew its EBIT by 140% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Revathi Equipment'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Revathi Equipment 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, Revathi Equipment recorded free cash flow worth a fulsome 92% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

We could understand if investors are concerned about Revathi Equipment's liabilities, but we can be reassured by the fact it has has net cash of ₹469.4m. And it impressed us with free cash flow of ₹389m, being 92% of its EBIT. So is Revathi Equipment's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Revathi Equipment has 1 warning sign we think you should be aware of.

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.