These 4 Measures Indicate That Ambica Agarbathies Aroma & Industries (NSE:AMBICAAGAR) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 can see that Ambica Agarbathies Aroma & Industries Limited (NSE:AMBICAAGAR) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ambica Agarbathies Aroma & Industries

How Much Debt Does Ambica Agarbathies Aroma & Industries Carry?

As you can see below, at the end of September 2024, Ambica Agarbathies Aroma & Industries had ₹825.0m of debt, up from ₹660.1m a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

How Strong Is Ambica Agarbathies Aroma & Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ambica Agarbathies Aroma & Industries had liabilities of ₹267.3m due within 12 months and liabilities of ₹915.1m due beyond that. On the other hand, it had cash of ₹16.3m and ₹120.4m worth of receivables due within a year. So its liabilities total ₹1.05b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₹437.7m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Ambica Agarbathies Aroma & Industries would likely require a major re-capitalisation if it had to pay its creditors today.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.1 times and a disturbingly high net debt to EBITDA ratio of 7.5 hit our confidence in Ambica Agarbathies Aroma & Industries like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Looking on the bright side, Ambica Agarbathies Aroma & Industries boosted its EBIT by a silky 42% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ambica Agarbathies Aroma & Industries 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Ambica Agarbathies Aroma & Industries reported free cash flow worth 15% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

To be frank both Ambica Agarbathies Aroma & Industries's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Ambica Agarbathies Aroma & Industries to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Ambica Agarbathies Aroma & Industries (including 3 which are significant) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.