These 4 Measures Indicate That IOL Chemicals and Pharmaceuticals (NSE:IOLCP) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 examine debt levels, we first consider both cash and debt levels, together.

See 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 IOL Chemicals and Pharmaceuticals had debt of ₹214.2m at the end of September 2020, a reduction from ₹948.5m over a year. However, it does have ₹2.86b in cash offsetting this, leading to net cash of ₹2.65b.

A Look At IOL Chemicals and Pharmaceuticals's Liabilities

Zooming in on the latest balance sheet data, we can see that IOL Chemicals and Pharmaceuticals had liabilities of ₹2.99b due within 12 months and liabilities of ₹596.6m due beyond that. Offsetting this, it had ₹2.86b in cash and ₹3.14b in receivables that were due within 12 months. So it actually has ₹2.42b more liquid assets than total liabilities.

This surplus suggests that IOL Chemicals and Pharmaceuticals has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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 8.1% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. 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. 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 free cash flow puts the company in a good position to pay down debt, when appropriate.

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. 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 instance, we've identified 3 warning signs for IOL Chemicals and Pharmaceuticals (1 is a bit concerning) 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. 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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