Does Kellton Tech Solutions (NSE:KELLTONTEC) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Kellton Tech Solutions Limited (NSE:KELLTONTEC) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Kellton Tech Solutions

What Is Kellton Tech Solutions's Net Debt?

The image below, which you can click on for greater detail, shows that Kellton Tech Solutions had debt of ₹1.01b at the end of March 2021, a reduction from ₹1.16b over a year. However, it does have ₹1.52b in cash offsetting this, leading to net cash of ₹508.1m.

A Look At Kellton Tech Solutions' Liabilities

According to the last reported balance sheet, Kellton Tech Solutions had liabilities of ₹1.64b due within 12 months, and liabilities of ₹470.5m due beyond 12 months. On the other hand, it had cash of ₹1.52b and ₹2.06b worth of receivables due within a year. So it can boast ₹1.47b more liquid assets than total liabilities.

This surplus suggests that Kellton Tech Solutions is using debt in a way that is appears to be both safe and conservative. 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 Kellton Tech Solutions has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Kellton Tech Solutions saw its EBIT drop by 5.9% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kellton Tech Solutions 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 company can only pay off debt with cold hard cash, not accounting profits. While Kellton Tech Solutions 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. Looking at the most recent three years, Kellton Tech Solutions recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kellton Tech Solutions has net cash of ₹508.1m, as well as more liquid assets than liabilities. So we don't have any problem with Kellton Tech Solutions's use of debt. 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. We've identified 2 warning signs with Kellton Tech Solutions , and understanding them should be part of your investment process.

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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