Does Yutaka GikenLtd (TYO:7229) 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, Yutaka Giken Co.,Ltd. (TYO:7229) does carry debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Yutaka GikenLtd

What Is Yutaka GikenLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Yutaka GikenLtd had debt of JP¥9.05b at the end of December 2020, a reduction from JP¥10.4b over a year. However, it does have JP¥31.5b in cash offsetting this, leading to net cash of JP¥22.5b.

How Healthy Is Yutaka GikenLtd's Balance Sheet?

According to the last reported balance sheet, Yutaka GikenLtd had liabilities of JP¥79.3b due within 12 months, and liabilities of JP¥6.65b due beyond 12 months. On the other hand, it had cash of JP¥31.5b and JP¥53.2b worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Since publicly traded Yutaka GikenLtd shares are worth a total of JP¥27.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Yutaka GikenLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Yutaka GikenLtd saw its EBIT decline by 8.8% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Yutaka GikenLtd 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. Yutaka GikenLtd 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, Yutaka GikenLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Yutaka GikenLtd has JP¥22.5b in net cash. The cherry on top was that in converted 103% of that EBIT to free cash flow, bringing in JP¥8.3b. So we don't think Yutaka GikenLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Yutaka GikenLtd you should be aware of, and 1 of them shouldn't be ignored.

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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