Ramco Systems (NSE:RAMCOSYS) Has A Pretty Healthy Balance Sheet

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.' 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, Ramco Systems Limited (NSE:RAMCOSYS) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Ramco Systems

What Is Ramco Systems's Net Debt?

As you can see below, Ramco Systems had ₹464.1m of debt at September 2020, down from ₹919.9m a year prior. However, it does have ₹1.10b in cash offsetting this, leading to net cash of ₹639.3m.

How Healthy Is Ramco Systems's Balance Sheet?

The latest balance sheet data shows that Ramco Systems had liabilities of ₹2.51b due within a year, and liabilities of ₹846.4m falling due after that. Offsetting this, it had ₹1.10b in cash and ₹2.00b in receivables that were due within 12 months. So its liabilities total ₹252.3m more than the combination of its cash and short-term receivables.

Having regard to Ramco Systems's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹18.6b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Ramco Systems boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Ramco Systems grew its EBIT by 33% 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 it is future earnings, more than anything, that will determine Ramco Systems's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Ramco Systems 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. Over the last three years, Ramco Systems recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ramco Systems has ₹639.3m in net cash. And we liked the look of last year's 33% year-on-year EBIT growth. So we don't have any problem with Ramco Systems's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Ramco Systems you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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