These 4 Measures Indicate That Voltas (NSE:VOLTAS) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Voltas Limited (NSE:VOLTAS) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Voltas

What Is Voltas's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Voltas had debt of ₹5.23b, up from ₹3.67b in one year. However, it does have ₹14.2b in cash offsetting this, leading to net cash of ₹8.96b.

A Look At Voltas' Liabilities

We can see from the most recent balance sheet that Voltas had liabilities of ₹40.7b falling due within a year, and liabilities of ₹1.80b due beyond that. Offsetting this, it had ₹14.2b in cash and ₹26.2b in receivables that were due within 12 months. So its liabilities total ₹2.13b more than the combination of its cash and short-term receivables.

Having regard to Voltas' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹276.1b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Voltas boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Voltas if management cannot prevent a repeat of the 22% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Voltas can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Voltas 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 three years, Voltas produced sturdy free cash flow equating to 80% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Voltas's liabilities, but we can be reassured by the fact it has has net cash of ₹8.96b. And it impressed us with free cash flow of ₹6.3b, being 80% of its EBIT. So we don't have any problem with Voltas's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Voltas is showing 2 warning signs in our investment analysis , you should know about...

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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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.