Cambridge Technology Enterprises (NSE:CTE) Seems To Use Debt Quite Sensibly

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. Importantly, Cambridge Technology Enterprises Limited (NSE:CTE) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Cambridge Technology Enterprises

How Much Debt Does Cambridge Technology Enterprises Carry?

As you can see below, at the end of September 2020, Cambridge Technology Enterprises had ₹121.4m of debt, up from ₹115.2m a year ago. Click the image for more detail. But it also has ₹296.1m in cash to offset that, meaning it has ₹174.7m net cash.

A Look At Cambridge Technology Enterprises's Liabilities

Zooming in on the latest balance sheet data, we can see that Cambridge Technology Enterprises had liabilities of ₹270.0m due within 12 months and liabilities of ₹81.4m due beyond that. Offsetting this, it had ₹296.1m in cash and ₹244.2m in receivables that were due within 12 months. So it actually has ₹188.9m more liquid assets than total liabilities.

This excess liquidity suggests that Cambridge Technology Enterprises is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Cambridge Technology Enterprises has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Cambridge Technology Enterprises if management cannot prevent a repeat of the 47% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Cambridge Technology Enterprises 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. Cambridge Technology Enterprises 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 last three years, Cambridge Technology Enterprises barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Cambridge Technology Enterprises has net cash of ₹174.7m, as well as more liquid assets than liabilities. So we don't have any problem with Cambridge Technology Enterprises's use of debt. 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 learn about the 3 warning signs we've spotted with Cambridge Technology Enterprises (including 2 which is can't be ignored) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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