These 4 Measures Indicate That Shoei YakuhinLtd (TYO:3537) Is Using Debt Reasonably Well

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. Importantly, Shoei Yakuhin Co.,Ltd. (TYO:3537) does carry debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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.

Check out our latest analysis for Shoei YakuhinLtd

What Is Shoei YakuhinLtd's Net Debt?

As you can see below, Shoei YakuhinLtd had JP¥647.0m of debt at September 2020, down from JP¥802.0m a year prior. But on the other hand it also has JP¥1.22b in cash, leading to a JP¥577.0m net cash position.

How Strong Is Shoei YakuhinLtd's Balance Sheet?

The latest balance sheet data shows that Shoei YakuhinLtd had liabilities of JP¥4.35b due within a year, and liabilities of JP¥1.97b falling due after that. Offsetting these obligations, it had cash of JP¥1.22b as well as receivables valued at JP¥5.03b due within 12 months. So these liquid assets roughly match the total liabilities.

Of course, Shoei YakuhinLtd has a market capitalization of JP¥3.22b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Shoei YakuhinLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Shoei YakuhinLtd's load is not too heavy, because its EBIT was down 55% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Shoei YakuhinLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shoei YakuhinLtd 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, Shoei YakuhinLtd's free cash flow amounted to 44% 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 look at a company's total liabilities, it is very reassuring that Shoei YakuhinLtd has JP¥577.0m in net cash. So we don't have any problem with Shoei YakuhinLtd's use of debt. 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. To that end, you should learn about the 3 warning signs we've spotted with Shoei YakuhinLtd (including 1 which is significant) .

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. 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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