IOL Chemicals and Pharmaceuticals (NSE:IOLCP) Has A Pretty Healthy Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 note that IOL Chemicals and Pharmaceuticals Limited (NSE:IOLCP) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for IOL Chemicals and Pharmaceuticals

What Is IOL Chemicals and Pharmaceuticals's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 IOL Chemicals and Pharmaceuticals had ₹796.3m of debt, an increase on ₹427.5m, over one year. However, because it has a cash reserve of ₹243.9m, its net debt is less, at about ₹552.4m.

A Look At IOL Chemicals and Pharmaceuticals' Liabilities

The latest balance sheet data shows that IOL Chemicals and Pharmaceuticals had liabilities of ₹4.56b due within a year, and liabilities of ₹581.5m falling due after that. On the other hand, it had cash of ₹243.9m and ₹5.07b worth of receivables due within a year. So it can boast ₹170.1m more liquid assets than total liabilities.

Having regard to IOL Chemicals and Pharmaceuticals' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹26.0b company is struggling for cash, we still think it's worth monitoring its balance sheet.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

IOL Chemicals and Pharmaceuticals's net debt is only 0.24 times its EBITDA. And its EBIT covers its interest expense a whopping 10.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, IOL Chemicals and Pharmaceuticals's EBIT dived 17%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if IOL Chemicals and Pharmaceuticals can strengthen its balance sheet over time. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, IOL Chemicals and Pharmaceuticals reported free cash flow worth 13% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

IOL Chemicals and Pharmaceuticals's net debt to EBITDA was a real positive on this analysis, as was its interest cover. In contrast, our confidence was undermined by its apparent struggle to grow its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about IOL Chemicals and Pharmaceuticals's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for IOL Chemicals and Pharmaceuticals that you should be aware of before investing here.

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.