These 4 Measures Indicate That Revathi Equipment (NSE:REVATHI) Is Using Debt Safely

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Revathi Equipment Limited (NSE:REVATHI) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, 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 our latest analysis for Revathi Equipment

What Is Revathi Equipment's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Revathi Equipment had debt of ₹185.4m, up from none in one year. But on the other hand it also has ₹417.6m in cash, leading to a ₹232.2m net cash position.

How Strong Is Revathi Equipment's Balance Sheet?

We can see from the most recent balance sheet that Revathi Equipment had liabilities of ₹615.2m falling due within a year, and liabilities of ₹71.5m due beyond that. Offsetting this, it had ₹417.6m in cash and ₹654.6m in receivables that were due within 12 months. So it can boast ₹385.4m more liquid assets than total liabilities.

This excess liquidity suggests that Revathi Equipment is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Revathi Equipment boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Revathi Equipment grew its EBIT at 16% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is Revathi Equipment's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Revathi Equipment 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. Over the last three years, Revathi Equipment actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Revathi Equipment has ₹232.2m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₹289m, being 110% 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. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Revathi Equipment (1 is a bit unpleasant) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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