Here's Why Vadivarhe Speciality Chemicals (NSE:VSCL) Can Afford Some Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Vadivarhe Speciality Chemicals Limited (NSE:VSCL) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 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 Vadivarhe Speciality Chemicals

How Much Debt Does Vadivarhe Speciality Chemicals Carry?

As you can see below, Vadivarhe Speciality Chemicals had ₹250.3m of debt at September 2023, down from ₹276.1m a year prior. However, because it has a cash reserve of ₹5.40m, its net debt is less, at about ₹244.9m.

How Healthy Is Vadivarhe Speciality Chemicals' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Vadivarhe Speciality Chemicals had liabilities of ₹148.4m due within 12 months and liabilities of ₹186.7m due beyond that. On the other hand, it had cash of ₹5.40m and ₹43.7m worth of receivables due within a year. So its liabilities total ₹286.0m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₹421.8m, so it does suggest shareholders should keep an eye on Vadivarhe Speciality Chemicals' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Vadivarhe Speciality Chemicals's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Vadivarhe Speciality Chemicals reported revenue of ₹370m, which is a gain of 10%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Vadivarhe Speciality Chemicals had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost ₹7.1m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of ₹28m. In the meantime, we consider the stock very risky. 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 Vadivarhe Speciality Chemicals has 3 warning signs (and 1 which is potentially serious) we think 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.