Is Aristo Bio-Tech and Lifescience (NSE:ARISTO) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Aristo Bio-Tech and Lifescience Limited (NSE:ARISTO) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Aristo Bio-Tech and Lifescience

What Is Aristo Bio-Tech and Lifescience's Net Debt?

The image below, which you can click on for greater detail, shows that Aristo Bio-Tech and Lifescience had debt of ₹208.8m at the end of March 2024, a reduction from ₹224.9m over a year. On the flip side, it has ₹6.37m in cash leading to net debt of about ₹202.4m.

A Look At Aristo Bio-Tech and Lifescience's Liabilities

We can see from the most recent balance sheet that Aristo Bio-Tech and Lifescience had liabilities of ₹835.7m falling due within a year, and liabilities of ₹101.1m due beyond that. Offsetting this, it had ₹6.37m in cash and ₹637.8m in receivables that were due within 12 months. So its liabilities total ₹292.6m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Aristo Bio-Tech and Lifescience is worth ₹716.2m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Aristo Bio-Tech and Lifescience's net debt is sitting at a very reasonable 2.4 times its EBITDA, while its EBIT covered its interest expense just 4.1 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Sadly, Aristo Bio-Tech and Lifescience's EBIT actually dropped 4.6% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But it is Aristo Bio-Tech and Lifescience's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Considering the last three years, Aristo Bio-Tech and Lifescience actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

We'd go so far as to say Aristo Bio-Tech and Lifescience's conversion of EBIT to free cash flow was disappointing. But at least its level of total liabilities is not so bad. Once we consider all the factors above, together, it seems to us that Aristo Bio-Tech and Lifescience's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. We've identified 4 warning signs with Aristo Bio-Tech and Lifescience (at least 2 which are significant) , and understanding them should be part of your investment process.

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.