Is Birlasoft (NSE:BSOFT) A Risky Investment?

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.' 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. As with many other companies Birlasoft Limited (NSE:BSOFT) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Birlasoft

What Is Birlasoft's Debt?

You can click the graphic below for the historical numbers, but it shows that Birlasoft had ₹1.02b of debt in March 2023, down from ₹1.23b, one year before. But it also has ₹10.3b in cash to offset that, meaning it has ₹9.31b net cash.

A Look At Birlasoft's Liabilities

The latest balance sheet data shows that Birlasoft had liabilities of ₹6.24b due within a year, and liabilities of ₹1.15b falling due after that. On the other hand, it had cash of ₹10.3b and ₹10.1b worth of receivables due within a year. So it can boast ₹13.0b more liquid assets than total liabilities.

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

In fact Birlasoft's saving grace is its low debt levels, because its EBIT has tanked 21% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Birlasoft's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Birlasoft 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, Birlasoft recorded free cash flow worth 76% 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 Birlasoft has ₹9.31b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in ₹5.0b. So we are not troubled with Birlasoft's debt use. 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. To that end, you should be aware of the 3 warning signs we've spotted with Birlasoft .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.