Does Alkem Laboratories (NSE:ALKEM) Have A Healthy Balance Sheet?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Alkem Laboratories Limited (NSE:ALKEM) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Alkem Laboratories

How Much Debt Does Alkem Laboratories Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Alkem Laboratories had debt of ₹18.4b, up from ₹17.1b in one year. However, its balance sheet shows it holds ₹27.6b in cash, so it actually has ₹9.19b net cash.

A Look At Alkem Laboratories' Liabilities

Zooming in on the latest balance sheet data, we can see that Alkem Laboratories had liabilities of ₹39.7b due within 12 months and liabilities of ₹5.27b due beyond that. Offsetting these obligations, it had cash of ₹27.6b as well as receivables valued at ₹21.7b due within 12 months. So it can boast ₹4.27b more liquid assets than total liabilities.

This state of affairs indicates that Alkem Laboratories' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₹363.2b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Alkem Laboratories has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Alkem Laboratories if management cannot prevent a repeat of the 33% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Alkem Laboratories 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. Alkem Laboratories 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. During the last three years, Alkem Laboratories produced sturdy free cash flow equating to 54% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Alkem Laboratories has ₹9.19b in net cash and a decent-looking balance sheet. So we don't have any problem with Alkem Laboratories's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Alkem Laboratories you should be aware of.

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.

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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.