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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that IOL Chemicals and Pharmaceuticals Limited (NSE:IOLCP) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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.

View our latest analysis for IOL Chemicals and Pharmaceuticals

How Much Debt Does IOL Chemicals and Pharmaceuticals Carry?

The image below, which you can click on for greater detail, shows that at March 2022 IOL Chemicals and Pharmaceuticals had debt of ₹427.5m, up from none in one year. But on the other hand it also has ₹1.42b in cash, leading to a ₹996.1m net cash position.

A Look At IOL Chemicals and Pharmaceuticals' Liabilities

According to the last reported balance sheet, IOL Chemicals and Pharmaceuticals had liabilities of ₹5.13b due within 12 months, and liabilities of ₹566.2m due beyond 12 months. Offsetting this, it had ₹1.42b in cash and ₹4.94b in receivables that were due within 12 months. So it actually has ₹660.3m 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!

The modesty of its debt load may become crucial for IOL Chemicals and Pharmaceuticals if management cannot prevent a repeat of the 61% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since IOL Chemicals and Pharmaceuticals will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While IOL Chemicals and Pharmaceuticals has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, IOL Chemicals and Pharmaceuticals recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case IOL Chemicals and Pharmaceuticals has ₹996.1m in net cash and a decent-looking balance sheet. So we are not troubled with IOL Chemicals and Pharmaceuticals's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example IOL Chemicals and Pharmaceuticals has 4 warning signs (and 1 which is significant) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.