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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Butterfly Gandhimathi Appliances Limited (NSE:BUTTERFLY) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Butterfly Gandhimathi Appliances

What Is Butterfly Gandhimathi Appliances's Debt?

The image below, which you can click on for greater detail, shows that Butterfly Gandhimathi Appliances had debt of ₹809.9m at the end of September 2020, a reduction from ₹1.71b over a year. However, it also had ₹353.9m in cash, and so its net debt is ₹456.0m.

How Strong Is Butterfly Gandhimathi Appliances' Balance Sheet?

We can see from the most recent balance sheet that Butterfly Gandhimathi Appliances had liabilities of ₹2.42b falling due within a year, and liabilities of ₹367.5m due beyond that. Offsetting these obligations, it had cash of ₹353.9m as well as receivables valued at ₹1.27b 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 ₹10.1b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 0.75 and interest cover of 2.8 times, it seems to us that Butterfly Gandhimathi Appliances is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. One way Butterfly Gandhimathi Appliances could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 11%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Butterfly Gandhimathi Appliances actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Butterfly Gandhimathi Appliances's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its interest cover. When we consider the range of factors above, it looks like Butterfly Gandhimathi Appliances is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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 Butterfly Gandhimathi Appliances (1 is potentially serious) you should be aware of.

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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