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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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, eClerx Services Limited (NSE:ECLERX) does carry debt. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
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What Is eClerx Services's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2019 eClerx Services had debt of ₹16.7m, up from none in one year. However, its balance sheet shows it holds ₹8.49b in cash, so it actually has ₹8.47b net cash.
A Look At eClerx Services's Liabilities
Zooming in on the latest balance sheet data, we can see that eClerx Services had liabilities of ₹1.48b due within 12 months and liabilities of ₹674.0m due beyond that. On the other hand, it had cash of ₹8.49b and ₹3.95b worth of receivables due within a year. So it actually has ₹10.3b more liquid assets than total liabilities.
This surplus liquidity suggests that eClerx Services's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Simply put, the fact that eClerx Services has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, eClerx Services's EBIT dived 19%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 eClerx Services 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.