These 4 Measures Indicate That Nippon Kanryu Industry (FKSE:1771) Is Using Debt Safely

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, Nippon Kanryu Industry Co., Ltd. (FKSE:1771) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

Check out our latest analysis for Nippon Kanryu Industry

What Is Nippon Kanryu Industry's Debt?

As you can see below, at the end of December 2020, Nippon Kanryu Industry had JP¥756.0m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has JP¥3.60b in cash, leading to a JP¥2.85b net cash position.

How Strong Is Nippon Kanryu Industry's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Nippon Kanryu Industry had liabilities of JP¥5.13b due within 12 months and liabilities of JP¥917.0m due beyond that. Offsetting these obligations, it had cash of JP¥3.60b as well as receivables valued at JP¥4.19b due within 12 months. So it actually has JP¥1.74b more liquid assets than total liabilities.

This excess liquidity is a great indication that Nippon Kanryu Industry's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Nippon Kanryu Industry has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Nippon Kanryu Industry has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Nippon Kanryu Industry's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Nippon Kanryu Industry 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, Nippon Kanryu Industry produced sturdy free cash flow equating to 51% 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 we empathize with investors who find debt concerning, you should keep in mind that Nippon Kanryu Industry has net cash of JP¥2.85b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 25% over the last year. So is Nippon Kanryu Industry'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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Nippon Kanryu Industry you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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