We Think Godrej Consumer Products (NSE:GODREJCP) Can Stay On Top Of Its Debt

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.' 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. As with many other companies Godrej Consumer Products Limited (NSE:GODREJCP) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Godrej Consumer Products

What Is Godrej Consumer Products's Net Debt?

As you can see below, Godrej Consumer Products had ₹17.0b of debt at March 2022, down from ₹19.0b a year prior. But it also has ₹19.3b in cash to offset that, meaning it has ₹2.28b net cash.

A Look At Godrej Consumer Products' Liabilities

According to the last reported balance sheet, Godrej Consumer Products had liabilities of ₹39.7b due within 12 months, and liabilities of ₹6.07b due beyond 12 months. On the other hand, it had cash of ₹19.3b and ₹11.6b worth of receivables due within a year. So its liabilities total ₹14.9b more than the combination of its cash and short-term receivables.

Having regard to Godrej Consumer Products' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹918.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Godrej Consumer Products boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Godrej Consumer Products saw its EBIT decline by 7.4% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Godrej Consumer Products 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

We could understand if investors are concerned about Godrej Consumer Products's liabilities, but we can be reassured by the fact it has has net cash of ₹2.28b. And it impressed us with free cash flow of ₹12b, being 67% of its EBIT. So we don't have any problem with Godrej Consumer Products's use of debt. 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 example, we've discovered 1 warning sign for Godrej Consumer Products 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.

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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.