Here's Why Vidhi Specialty Food Ingredients (NSE:VIDHIING) 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 note that Vidhi Specialty Food Ingredients Limited (NSE:VIDHIING) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Vidhi Specialty Food Ingredients

What Is Vidhi Specialty Food Ingredients's Debt?

As you can see below, at the end of September 2021, Vidhi Specialty Food Ingredients had ₹718.8m of debt, up from ₹66.6m a year ago. Click the image for more detail. However, it does have ₹157.5m in cash offsetting this, leading to net debt of about ₹561.2m.

How Healthy Is Vidhi Specialty Food Ingredients' Balance Sheet?

We can see from the most recent balance sheet that Vidhi Specialty Food Ingredients had liabilities of ₹1.01b falling due within a year, and liabilities of ₹172.3m due beyond that. On the other hand, it had cash of ₹157.5m and ₹1.26b worth of receivables due within a year. So it actually has ₹231.5m more liquid assets than total liabilities.

Having regard to Vidhi Specialty Food Ingredients' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹18.5b company is short on cash, but still worth keeping an eye on the balance sheet.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

Vidhi Specialty Food Ingredients's net debt is only 0.77 times its EBITDA. And its EBIT covers its interest expense a whopping 91.0 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Vidhi Specialty Food Ingredients has boosted its EBIT by 60%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Vidhi Specialty Food Ingredients's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Vidhi Specialty Food Ingredients created free cash flow amounting to 3.5% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

The good news is that Vidhi Specialty Food Ingredients's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that Vidhi Specialty Food Ingredients takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Vidhi Specialty Food Ingredients you should know about.

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.