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 can see that Kakatiya Cement Sugar and Industries Limited (NSE:KAKATCEM) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Kakatiya Cement Sugar and Industries's Net Debt?
As you can see below, Kakatiya Cement Sugar and Industries had ₹128.1m of debt at September 2021, down from ₹289.2m a year prior. However, it does have ₹1.02b in cash offsetting this, leading to net cash of ₹892.8m.
How Strong Is Kakatiya Cement Sugar and Industries' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Kakatiya Cement Sugar and Industries had liabilities of ₹576.6m due within 12 months and liabilities of ₹100.5m due beyond that. Offsetting these obligations, it had cash of ₹1.02b as well as receivables valued at ₹203.2m due within 12 months. So it can boast ₹547.0m more liquid assets than total liabilities.
It's good to see that Kakatiya Cement Sugar and Industries has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Kakatiya Cement Sugar and Industries has more cash than debt is arguably a good indication that it can manage its debt safely.
Even more impressive was the fact that Kakatiya Cement Sugar and Industries grew its EBIT by 547% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kakatiya Cement Sugar and Industries will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Kakatiya Cement Sugar and Industries 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. Happily for any shareholders, Kakatiya Cement Sugar and Industries actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While we empathize with investors who find debt concerning, you should keep in mind that Kakatiya Cement Sugar and Industries has net cash of ₹892.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 312% of that EBIT to free cash flow, bringing in ₹70m. The bottom line is that we do not find Kakatiya Cement Sugar and Industries's debt levels at all concerning. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Kakatiya Cement Sugar and Industries has 2 warning signs (and 1 which can't be ignored) we think you should know about.
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.
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.