Here's Why Gujarat State Fertilizers & Chemicals (NSE:GSFC) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, Gujarat State Fertilizers & Chemicals Limited (NSE:GSFC) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Gujarat State Fertilizers & Chemicals

What Is Gujarat State Fertilizers & Chemicals's Net Debt?

As you can see below, at the end of September 2024, Gujarat State Fertilizers & Chemicals had ₹984.7m of debt, up from none a year ago. Click the image for more detail. However, it does have ₹23.7b in cash offsetting this, leading to net cash of ₹22.8b.

How Strong Is Gujarat State Fertilizers & Chemicals' Balance Sheet?

The latest balance sheet data shows that Gujarat State Fertilizers & Chemicals had liabilities of ₹13.5b due within a year, and liabilities of ₹11.2b falling due after that. Offsetting this, it had ₹23.7b in cash and ₹20.6b in receivables that were due within 12 months. So it can boast ₹19.6b more liquid assets than total liabilities.

It's good to see that Gujarat State Fertilizers & Chemicals has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Gujarat State Fertilizers & Chemicals boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Gujarat State Fertilizers & Chemicals if management cannot prevent a repeat of the 55% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Gujarat State Fertilizers & Chemicals's ability to maintain a healthy balance sheet going forward. 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. While Gujarat State Fertilizers & Chemicals 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. In the last three years, Gujarat State Fertilizers & Chemicals created free cash flow amounting to 14% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Gujarat State Fertilizers & Chemicals has ₹22.8b in net cash and a decent-looking balance sheet. So we don't have any problem with Gujarat State Fertilizers & Chemicals's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Gujarat State Fertilizers & Chemicals .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.