Is Godrej Consumer Products (NSE:GODREJCP) A Risky Investment?

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 Godrej Consumer Products Limited (NSE:GODREJCP) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Godrej Consumer Products

How Much Debt Does Godrej Consumer Products Carry?

As you can see below, Godrej Consumer Products had ₹10.3b of debt at March 2023, down from ₹16.1b a year prior. However, its balance sheet shows it holds ₹25.8b in cash, so it actually has ₹15.5b net cash.

How Healthy Is Godrej Consumer Products' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Godrej Consumer Products had liabilities of ₹32.9b due within 12 months and liabilities of ₹4.13b due beyond that. Offsetting these obligations, it had cash of ₹25.8b as well as receivables valued at ₹12.5b due within 12 months. So it can boast ₹1.21b more liquid assets than total liabilities.

This state of affairs indicates that Godrej Consumer Products' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹1.06t company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Godrej Consumer Products has more cash than debt is arguably a good indication that it can manage its debt safely.

Godrej Consumer Products's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Godrej Consumer Products's ability to maintain a healthy balance sheet going forward. 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. Godrej Consumer Products may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Godrej Consumer Products recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Godrej Consumer Products has ₹15.5b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in ₹19b. So is Godrej Consumer Products's debt a risk? It doesn't seem so to us. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Godrej Consumer Products insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.