Is Advanced Enzyme Technologies (NSE:ADVENZYMES) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Advanced Enzyme Technologies Limited (NSE:ADVENZYMES) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Advanced Enzyme Technologies Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Advanced Enzyme Technologies had debt of ₹469.2m, up from ₹388.6m in one year. However, it does have ₹5.07b in cash offsetting this, leading to net cash of ₹4.60b.

A Look At Advanced Enzyme Technologies' Liabilities

We can see from the most recent balance sheet that Advanced Enzyme Technologies had liabilities of ₹1.04b falling due within a year, and liabilities of ₹564.4m due beyond that. Offsetting this, it had ₹5.07b in cash and ₹1.01b in receivables that were due within 12 months. So it actually has ₹4.47b more liquid assets than total liabilities.

This surplus suggests that Advanced Enzyme Technologies has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Advanced Enzyme Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.

Check out our latest analysis for Advanced Enzyme Technologies

The good news is that Advanced Enzyme Technologies has increased its EBIT by 3.5% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Advanced Enzyme Technologies will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Advanced Enzyme Technologies has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Advanced Enzyme Technologies produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Advanced Enzyme Technologies has net cash of ₹4.60b, as well as more liquid assets than liabilities. So we don't think Advanced Enzyme Technologies's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Advanced Enzyme Technologies that 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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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.