Is Cambridge Technology Enterprises (NSE:CTE) 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.' 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 Cambridge Technology Enterprises Limited (NSE:CTE) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. 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

What Is Cambridge Technology Enterprises's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Cambridge Technology Enterprises had debt of ₹141.1m, up from ₹121.4m in one year. But it also has ₹427.6m in cash to offset that, meaning it has ₹286.5m net cash.

How Strong Is Cambridge Technology Enterprises' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cambridge Technology Enterprises had liabilities of ₹243.1m due within 12 months and liabilities of ₹92.6m due beyond that. On the other hand, it had cash of ₹427.6m and ₹251.3m worth of receivables due within a year. So it actually has ₹343.1m more liquid assets than total liabilities.

It's good to see that Cambridge Technology Enterprises has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble 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.

In fact Cambridge Technology Enterprises's saving grace is its low debt levels, because its EBIT has tanked 63% 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 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. Looking at the most recent three years, Cambridge Technology Enterprises recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Cambridge Technology Enterprises has net cash of ₹286.5m, as well as more liquid assets than liabilities. So we are not troubled with Cambridge Technology Enterprises'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 learn about the 5 warning signs we've spotted with Cambridge Technology Enterprises (including 1 which can't be ignored) .

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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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.