Here's Why Gujarat Fluorochemicals (NSE:FLUOROCHEM) Can Manage Its Debt Responsibly

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.' 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 Gujarat Fluorochemicals Limited (NSE:FLUOROCHEM) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Gujarat Fluorochemicals

How Much Debt Does Gujarat Fluorochemicals Carry?

The image below, which you can click on for greater detail, shows that at March 2022 Gujarat Fluorochemicals had debt of ₹15.6b, up from ₹14.1b in one year. On the flip side, it has ₹1.72b in cash leading to net debt of about ₹13.8b.

How Strong Is Gujarat Fluorochemicals' Balance Sheet?

According to the last reported balance sheet, Gujarat Fluorochemicals had liabilities of ₹19.1b due within 12 months, and liabilities of ₹7.41b due beyond 12 months. On the other hand, it had cash of ₹1.72b and ₹11.7b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹13.1b.

Since publicly traded Gujarat Fluorochemicals shares are worth a total of ₹397.7b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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 1.0. And its EBIT covers its interest expense a whopping 15.5 times over. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Gujarat Fluorochemicals grew its EBIT by 129% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Gujarat Fluorochemicals 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Gujarat Fluorochemicals basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Our View

Happily, Gujarat Fluorochemicals's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. When we consider the range of factors above, it looks like Gujarat Fluorochemicals is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. Over time, share prices tend to follow earnings per share, so if you're interested in Gujarat Fluorochemicals, you may well want to click here to check an interactive graph of its earnings per share history.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.