We Think Cambridge Technology Enterprises (NSE:CTE) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Cambridge Technology Enterprises Limited (NSE:CTE) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out 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 March 2023 Cambridge Technology Enterprises had debt of ₹568.1m, up from ₹331.4m in one year. However, because it has a cash reserve of ₹277.5m, its net debt is less, at about ₹290.6m.

How Healthy Is Cambridge Technology Enterprises' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cambridge Technology Enterprises had liabilities of ₹435.7m due within 12 months and liabilities of ₹339.1m due beyond that. On the other hand, it had cash of ₹277.5m and ₹553.2m worth of receivables due within a year. So it can boast ₹55.9m more liquid assets than total liabilities.

This surplus suggests that Cambridge Technology Enterprises has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 1.3 and interest cover of 4.6 times, it seems to us that Cambridge Technology Enterprises is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Also relevant is that Cambridge Technology Enterprises has grown its EBIT by a very respectable 25% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. 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. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Cambridge Technology Enterprises saw substantial negative free cash flow, in total. 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.

Our View

Cambridge Technology Enterprises's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. When we consider all the elements mentioned above, it seems to us that Cambridge Technology Enterprises is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Cambridge Technology Enterprises you should be aware of, and 2 of them 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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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.