Here's Why Ipca Laboratories (NSE:IPCALAB) Can Manage Its Debt Responsibly

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.' 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 Ipca Laboratories Limited (NSE:IPCALAB) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ipca Laboratories

How Much Debt Does Ipca Laboratories Carry?

As you can see below, at the end of March 2022, Ipca Laboratories had ₹8.07b of debt, up from ₹2.65b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₹13.6b in cash, so it actually has ₹5.53b net cash.

A Look At Ipca Laboratories' Liabilities

The latest balance sheet data shows that Ipca Laboratories had liabilities of ₹14.7b due within a year, and liabilities of ₹6.04b falling due after that. On the other hand, it had cash of ₹13.6b and ₹11.4b worth of receivables due within a year. So it actually has ₹4.27b more liquid assets than total liabilities.

This state of affairs indicates that Ipca Laboratories' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹217.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Ipca Laboratories boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Ipca Laboratories's saving grace is its low debt levels, because its EBIT has tanked 20% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Ipca Laboratories 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Ipca Laboratories 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. Looking at the most recent three years, Ipca Laboratories recorded free cash flow of 45% 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 Ipca Laboratories has ₹5.53b in net cash and a decent-looking balance sheet. So we are not troubled with Ipca Laboratories's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Ipca Laboratories .

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. 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.