Does Butterfly Gandhimathi Appliances (NSE:BUTTERFLY) Have A Healthy Balance Sheet?

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.' 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. We note that Butterfly Gandhimathi Appliances Limited (NSE:BUTTERFLY) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Butterfly Gandhimathi Appliances

How Much Debt Does Butterfly Gandhimathi Appliances Carry?

You can click the graphic below for the historical numbers, but it shows that Butterfly Gandhimathi Appliances had ₹809.9m of debt in September 2020, down from ₹1.71b, one year before. On the flip side, it has ₹353.9m in cash leading to net debt of about ₹456.0m.

How Strong Is Butterfly Gandhimathi Appliances's Balance Sheet?

The latest balance sheet data shows that Butterfly Gandhimathi Appliances had liabilities of ₹2.42b due within a year, and liabilities of ₹367.5m falling due after that. Offsetting this, it had ₹353.9m in cash and ₹1.27b in receivables that were due within 12 months. So its liabilities total ₹1.17b more than the combination of its cash and short-term receivables.

Given Butterfly Gandhimathi Appliances has a market capitalization of ₹6.83b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Butterfly Gandhimathi Appliances has a very low debt to EBITDA ratio of 1.2 so it is strange to see weak interest coverage, with last year's EBIT being only 1.2 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Importantly, Butterfly Gandhimathi Appliances's EBIT fell a jaw-dropping 40% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is Butterfly Gandhimathi Appliances'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. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Butterfly Gandhimathi Appliances actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Butterfly Gandhimathi Appliances's EBIT growth rate and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Looking at all the angles mentioned above, it does seem to us that Butterfly Gandhimathi Appliances is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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 Butterfly Gandhimathi Appliances is showing 5 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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. 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.
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