Is Tokai Rika (TSE:6995) Using Too Much Debt?

Warren Buffett famously said, '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. We can see that Tokai Rika Co., Ltd. (TSE:6995) does use debt in its business. 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. 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. 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 Tokai Rika

What Is Tokai Rika's Debt?

As you can see below, Tokai Rika had JP¥10.0b of debt at December 2023, down from JP¥12.0b a year prior. But it also has JP¥87.4b in cash to offset that, meaning it has JP¥77.4b net cash.

How Strong Is Tokai Rika's Balance Sheet?

The latest balance sheet data shows that Tokai Rika had liabilities of JP¥121.3b due within a year, and liabilities of JP¥42.1b falling due after that. Offsetting this, it had JP¥87.4b in cash and JP¥97.6b in receivables that were due within 12 months. So it actually has JP¥21.7b more liquid assets than total liabilities.

This surplus suggests that Tokai Rika has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Tokai Rika has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Tokai Rika grew its EBIT by 702% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Tokai Rika'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. Tokai Rika 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. In the last three years, Tokai Rika's free cash flow amounted to 43% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Tokai Rika has JP¥77.4b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 702% over the last year. So we don't think Tokai Rika's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Tokai Rika you should be aware of, and 1 of them is a bit concerning.

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.