Larsen & Toubro Infotech (NSE:LTI) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Larsen & Toubro Infotech Limited (NSE:LTI) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Larsen & Toubro Infotech

What Is Larsen & Toubro Infotech's Debt?

As you can see below, at the end of December 2021, Larsen & Toubro Infotech had ₹309.0m of debt, up from ₹176.0m a year ago. Click the image for more detail. However, it does have ₹36.1b in cash offsetting this, leading to net cash of ₹35.8b.

How Healthy Is Larsen & Toubro Infotech's Balance Sheet?

We can see from the most recent balance sheet that Larsen & Toubro Infotech had liabilities of ₹27.5b falling due within a year, and liabilities of ₹7.12b due beyond that. Offsetting this, it had ₹36.1b in cash and ₹34.6b in receivables that were due within 12 months. So it can boast ₹36.1b more liquid assets than total liabilities.

This short term liquidity is a sign that Larsen & Toubro Infotech could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Larsen & Toubro Infotech has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Larsen & Toubro Infotech grew its EBIT by 15% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Larsen & Toubro Infotech can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Larsen & Toubro Infotech 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, Larsen & Toubro Infotech produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Larsen & Toubro Infotech has net cash of ₹35.8b, as well as more liquid assets than liabilities. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in ₹14b. So is Larsen & Toubro Infotech's debt a risk? It doesn't seem so to us. 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. For example Larsen & Toubro Infotech has 4 warning signs (and 1 which is a bit concerning) we think you should know about.

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.