Does Gujarat Fluorochemicals (NSE:FLUOROCHEM) Have A Healthy Balance Sheet?

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 note that Gujarat Fluorochemicals Limited (NSE:FLUOROCHEM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Gujarat Fluorochemicals

What Is Gujarat Fluorochemicals's Debt?

The image below, which you can click on for greater detail, shows that Gujarat Fluorochemicals had debt of ₹14.8b at the end of March 2023, a reduction from ₹15.5b over a year. However, it also had ₹1.61b in cash, and so its net debt is ₹13.2b.

A Look At Gujarat Fluorochemicals' Liabilities

Zooming in on the latest balance sheet data, we can see that Gujarat Fluorochemicals had liabilities of ₹23.4b due within 12 months and liabilities of ₹5.12b due beyond that. On the other hand, it had cash of ₹1.61b and ₹11.3b worth of receivables due within a year. So its liabilities total ₹15.6b more than the combination of its cash and short-term receivables.

Of course, Gujarat Fluorochemicals has a market capitalization of ₹297.0b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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).

Gujarat Fluorochemicals has a low net debt to EBITDA ratio of only 0.67. And its EBIT covers its interest expense a whopping 14.8 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Gujarat Fluorochemicals has boosted its EBIT by 78%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Gujarat Fluorochemicals 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Gujarat Fluorochemicals reported free cash flow worth 15% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

The good news is that Gujarat Fluorochemicals's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. When we consider the range of factors above, it looks like Gujarat Fluorochemicals is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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 1 warning sign for Gujarat Fluorochemicals that you should be aware of before investing here.

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.