Indo Rama Synthetics (India) (NSE:INDORAMA) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Indo Rama Synthetics (India) Limited (NSE:INDORAMA) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Indo Rama Synthetics (India)

What Is Indo Rama Synthetics (India)'s Net Debt?

As you can see below, Indo Rama Synthetics (India) had ₹3.22b of debt at March 2022, down from ₹3.81b a year prior. However, it does have ₹123.2m in cash offsetting this, leading to net debt of about ₹3.09b.

How Healthy Is Indo Rama Synthetics (India)'s Balance Sheet?

The latest balance sheet data shows that Indo Rama Synthetics (India) had liabilities of ₹12.7b due within a year, and liabilities of ₹2.36b falling due after that. On the other hand, it had cash of ₹123.2m and ₹1.84b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹13.1b.

This deficit is considerable relative to its market capitalization of ₹18.2b, so it does suggest shareholders should keep an eye on Indo Rama Synthetics (India)'s use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Indo Rama Synthetics (India)'s low debt to EBITDA ratio of 1.0 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.4 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Pleasingly, Indo Rama Synthetics (India) is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 378% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Indo Rama Synthetics (India)'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last two years, Indo Rama Synthetics (India) generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Indo Rama Synthetics (India)'s impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its level of total liabilities. Taking all this data into account, it seems to us that Indo Rama Synthetics (India) takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. For example, we've discovered 1 warning sign for Indo Rama Synthetics (India) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.