Is IOL Chemicals and Pharmaceuticals (NSE:IOLCP) Using Too Much Debt?

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. Importantly, IOL Chemicals and Pharmaceuticals Limited (NSE:IOLCP) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for IOL Chemicals and Pharmaceuticals

How Much Debt Does IOL Chemicals and Pharmaceuticals Carry?

As you can see below, IOL Chemicals and Pharmaceuticals had ₹214.2m of debt at September 2020, down from ₹986.9m a year prior. But on the other hand it also has ₹2.86b in cash, leading to a ₹2.65b net cash position.

How Healthy Is IOL Chemicals and Pharmaceuticals' Balance Sheet?

We can see from the most recent balance sheet that IOL Chemicals and Pharmaceuticals had liabilities of ₹2.99b falling due within a year, and liabilities of ₹596.6m due beyond that. Offsetting these obligations, it had cash of ₹2.86b as well as receivables valued at ₹3.14b due within 12 months. So it can boast ₹2.42b more liquid assets than total liabilities.

This short term liquidity is a sign that IOL Chemicals and Pharmaceuticals could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, IOL Chemicals and Pharmaceuticals boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, IOL Chemicals and Pharmaceuticals grew its EBIT by 3.5% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is IOL Chemicals and Pharmaceuticals'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. IOL Chemicals and Pharmaceuticals 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. Over the most recent three years, IOL Chemicals and Pharmaceuticals recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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 IOL Chemicals and Pharmaceuticals has ₹2.65b in net cash and a decent-looking balance sheet. So we don't think IOL Chemicals and Pharmaceuticals's use of debt is risky. 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, we've discovered 3 warning signs for IOL Chemicals and Pharmaceuticals that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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.
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