Is Shakti Pumps (India) (NSE:SHAKTIPUMP) Using Too Much Debt?

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. We note that Shakti Pumps (India) Limited (NSE:SHAKTIPUMP) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Shakti Pumps (India)

What Is Shakti Pumps (India)'s Debt?

As you can see below, at the end of March 2024, Shakti Pumps (India) had ₹829.1m of debt, up from ₹734.0m a year ago. Click the image for more detail. But it also has ₹2.01b in cash to offset that, meaning it has ₹1.18b net cash.

How Strong Is Shakti Pumps (India)'s Balance Sheet?

According to the last reported balance sheet, Shakti Pumps (India) had liabilities of ₹6.85b due within 12 months, and liabilities of ₹98.0m due beyond 12 months. Offsetting these obligations, it had cash of ₹2.01b as well as receivables valued at ₹6.67b due within 12 months. So it can boast ₹1.74b more liquid assets than total liabilities.

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

Even more impressive was the fact that Shakti Pumps (India) grew its EBIT by 313% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shakti Pumps (India) will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shakti Pumps (India) 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, Shakti Pumps (India) recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shakti Pumps (India) has ₹1.18b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 313% over the last year. So we are not troubled with Shakti Pumps (India)'s debt use. 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. We've identified 2 warning signs with Shakti Pumps (India) (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.