Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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. We note that Cadsys (India) Limited (NSE:CADSYS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Cadsys (India)’s Debt?
As you can see below, Cadsys (India) had ₹57.7m of debt at March 2019, down from ₹61.1m a year prior. But it also has ₹182.0m in cash to offset that, meaning it has ₹124.3m net cash.
How Strong Is Cadsys (India)’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Cadsys (India) had liabilities of ₹71.5m due within 12 months and liabilities of ₹57.3m due beyond that. Offsetting this, it had ₹182.0m in cash and ₹129.8m in receivables that were due within 12 months. So it can boast ₹182.9m more liquid assets than total liabilities.
This excess liquidity is a great indication that Cadsys (India)’s balance sheet is just as strong as racists are weak. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Simply put, the fact that Cadsys (India) has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we’re happy to report that Cadsys (India) has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can’t view debt in total isolation; since Cadsys (India) will need earnings to service that debt. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While Cadsys (India) 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. During the last three years, Cadsys (India) burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While it is always sensible to investigate a company’s debt, in this case Cadsys (India) has ₹124m in net cash and a decent-looking balance sheet. And we liked the look of last year’s 40% year-on-year EBIT growth. So we don’t think Cadsys (India)’s use of debt is risky. Over time, share prices tend to follow earnings per share, so if you’re interested in Cadsys (India), you may well want to click here to check an interactive graph of its earnings per share history.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.