YAPP Automotive Systems (SHSE:603013) Could Easily Take On More 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies YAPP Automotive Systems Co., Ltd. (SHSE:603013) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 YAPP Automotive Systems

What Is YAPP Automotive Systems's Net Debt?

The image below, which you can click on for greater detail, shows that YAPP Automotive Systems had debt of CN¥84.4m at the end of March 2024, a reduction from CN¥171.8m over a year. However, it does have CN¥2.03b in cash offsetting this, leading to net cash of CN¥1.95b.

How Strong Is YAPP Automotive Systems' Balance Sheet?

According to the last reported balance sheet, YAPP Automotive Systems had liabilities of CN¥2.00b due within 12 months, and liabilities of CN¥335.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.03b as well as receivables valued at CN¥1.65b due within 12 months. So it can boast CN¥1.35b more liquid assets than total liabilities.

This surplus suggests that YAPP Automotive Systems is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that YAPP Automotive Systems has more cash than debt is arguably a good indication that it can manage its debt safely.

While YAPP Automotive Systems doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since YAPP Automotive Systems 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. YAPP Automotive Systems 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, YAPP Automotive Systems actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that YAPP Automotive Systems has net cash of CN¥1.95b, as well as more liquid assets than liabilities. The cherry on top was that in converted 107% of that EBIT to free cash flow, bringing in CN¥914m. So we don't think YAPP Automotive Systems's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for YAPP Automotive Systems 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.

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