Is Datamatics Global Services (NSE:DATAMATICS) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Datamatics Global Services Limited (NSE:DATAMATICS) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Datamatics Global Services

What Is Datamatics Global Services's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Datamatics Global Services had debt of ₹241.8m, up from none in one year. But on the other hand it also has ₹3.53b in cash, leading to a ₹3.29b net cash position.

How Healthy Is Datamatics Global Services' Balance Sheet?

According to the last reported balance sheet, Datamatics Global Services had liabilities of ₹1.76b due within 12 months, and liabilities of ₹390.6m due beyond 12 months. Offsetting this, it had ₹3.53b in cash and ₹2.01b in receivables that were due within 12 months. So it actually has ₹3.40b more liquid assets than total liabilities.

It's good to see that Datamatics Global Services 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 Datamatics Global Services has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Datamatics Global Services grew its EBIT by 67% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Datamatics Global Services 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. Datamatics Global Services 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, Datamatics Global Services recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Datamatics Global Services has net cash of ₹3.29b, as well as more liquid assets than liabilities. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in ₹1.3b. The bottom line is that we do not find Datamatics Global Services's debt levels at all concerning. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Datamatics Global Services you should know about.

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.