Does Ipca Laboratories (NSE:IPCALAB) Have A Healthy Balance Sheet?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Ipca Laboratories Limited (NSE:IPCALAB) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Ipca Laboratories

What Is Ipca Laboratories's Net Debt?

The image below, which you can click on for greater detail, shows that Ipca Laboratories had debt of ₹3.07b at the end of September 2021, a reduction from ₹3.35b over a year. But on the other hand it also has ₹9.69b in cash, leading to a ₹6.62b net cash position.

How Strong Is Ipca Laboratories' Balance Sheet?

We can see from the most recent balance sheet that Ipca Laboratories had liabilities of ₹12.9b falling due within a year, and liabilities of ₹2.07b due beyond that. On the other hand, it had cash of ₹9.69b and ₹10.7b worth of receivables due within a year. So it actually has ₹5.45b more liquid assets than total liabilities.

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

On the other hand, Ipca Laboratories's EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Ipca Laboratories's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Ipca Laboratories 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. In the last three years, Ipca Laboratories's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Ipca Laboratories has ₹6.62b in net cash and a decent-looking balance sheet. So we are not troubled with Ipca Laboratories'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. To that end, you should be aware of the 1 warning sign we've spotted with Ipca Laboratories .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.