Does Atul (NSE:ATUL) Have A Healthy Balance Sheet?

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.' 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. Importantly, Atul Ltd (NSE:ATUL) does carry 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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Atul

What Is Atul's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Atul had ₹1.38b of debt, an increase on ₹1.27b, over one year. However, its balance sheet shows it holds ₹6.19b in cash, so it actually has ₹4.81b net cash.

How Strong Is Atul's Balance Sheet?

The latest balance sheet data shows that Atul had liabilities of ₹9.99b due within a year, and liabilities of ₹2.48b falling due after that. Offsetting these obligations, it had cash of ₹6.19b as well as receivables valued at ₹9.89b due within 12 months. So it actually has ₹3.62b more liquid assets than total liabilities.

Having regard to Atul's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹248.8b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Atul boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Atul saw its EBIT drop by 6.1% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Atul 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. Atul 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. Looking at the most recent three years, Atul recorded free cash flow of 24% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Atul has ₹4.81b in net cash and a decent-looking balance sheet. So we are not troubled with Atul's debt use. 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 example, we've discovered 2 warning signs for Atul (1 shouldn't be ignored!) 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.