Does Castrol India (NSE:CASTROLIND) Have A Healthy Balance Sheet?

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 Castrol India Limited (NSE:CASTROLIND) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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.

See our latest analysis for Castrol India

What Is Castrol India's Net Debt?

As you can see below, at the end of June 2024, Castrol India had ₹733.3m of debt, up from ₹639.0m a year ago. Click the image for more detail. But it also has ₹12.6b in cash to offset that, meaning it has ₹11.9b net cash.

How Healthy Is Castrol India's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Castrol India had liabilities of ₹12.7b due within 12 months and liabilities of ₹777.5m due beyond that. Offsetting this, it had ₹12.6b in cash and ₹5.22b in receivables that were due within 12 months. So it actually has ₹4.40b more liquid assets than total liabilities.

This short term liquidity is a sign that Castrol India could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Castrol India boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Castrol India has increased its EBIT by 8.4% 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 ultimately the future profitability of the business will decide if Castrol India can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Castrol India 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. Over the most recent three years, Castrol India recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Castrol India has ₹11.9b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in ₹9.8b. So we don't think Castrol India's use of debt is risky. Another factor that would give us confidence in Castrol India would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.