Is Koito Manufacturing (TSE:7276) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Koito Manufacturing Co., Ltd. (TSE:7276) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Koito Manufacturing

How Much Debt Does Koito Manufacturing Carry?

As you can see below, Koito Manufacturing had JP¥14.3b of debt at March 2024, down from JP¥22.6b a year prior. But it also has JP¥302.9b in cash to offset that, meaning it has JP¥288.6b net cash.

A Look At Koito Manufacturing's Liabilities

The latest balance sheet data shows that Koito Manufacturing had liabilities of JP¥192.5b due within a year, and liabilities of JP¥53.8b falling due after that. Offsetting this, it had JP¥302.9b in cash and JP¥142.3b in receivables that were due within 12 months. So it actually has JP¥198.9b more liquid assets than total liabilities.

This excess liquidity suggests that Koito Manufacturing is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Koito Manufacturing has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Koito Manufacturing grew its EBIT at 20% over the last year, further increasing its ability to manage 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 Koito Manufacturing'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Koito Manufacturing 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. During the last three years, Koito Manufacturing produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Koito Manufacturing has JP¥288.6b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 74% of that EBIT to free cash flow, bringing in JP¥59b. So is Koito Manufacturing's debt a risk? It doesn't seem so to us. 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 2 warning signs for Koito Manufacturing you should be aware of, and 1 of them is potentially serious.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.