Here's Why Cambridge Technology Enterprises (NSE:CTE) Can Manage Its Debt Responsibly

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Cambridge Technology Enterprises Limited (NSE:CTE) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View 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 2022, Cambridge Technology Enterprises had ₹434.5m of debt, up from ₹141.1m a year ago. Click the image for more detail. But it also has ₹521.0m in cash to offset that, meaning it has ₹86.6m net cash.

A Look At Cambridge Technology Enterprises' Liabilities

According to the last reported balance sheet, Cambridge Technology Enterprises had liabilities of ₹303.4m due within 12 months, and liabilities of ₹315.2m due beyond 12 months. Offsetting this, it had ₹521.0m in cash and ₹351.4m in receivables that were due within 12 months. So it actually has ₹253.9m 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.

Better yet, Cambridge Technology Enterprises grew its EBIT by 364% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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. While Cambridge Technology Enterprises 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, Cambridge Technology Enterprises burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Cambridge Technology Enterprises has ₹86.6m in net cash and a decent-looking balance sheet. And we liked the look of last year's 364% year-on-year EBIT growth. So is Cambridge Technology Enterprises's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Cambridge Technology Enterprises you should be aware of, and 2 of them are significant.

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.