Does Tohoku Chemical (TYO:7446) Have A Healthy Balance Sheet?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Tohoku Chemical Co., Ltd. (TYO:7446) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Tohoku Chemical

How Much Debt Does Tohoku Chemical Carry?

The image below, which you can click on for greater detail, shows that Tohoku Chemical had debt of JP¥195.0m at the end of December 2020, a reduction from JP¥466.0m over a year. However, its balance sheet shows it holds JP¥1.99b in cash, so it actually has JP¥1.80b net cash.

A Look At Tohoku Chemical's Liabilities

We can see from the most recent balance sheet that Tohoku Chemical had liabilities of JP¥9.89b falling due within a year, and liabilities of JP¥1.01b due beyond that. Offsetting this, it had JP¥1.99b in cash and JP¥8.32b in receivables that were due within 12 months. So its liabilities total JP¥587.0m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Tohoku Chemical has a market capitalization of JP¥2.87b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Tohoku Chemical boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Tohoku Chemical grew its EBIT by 101% over twelve months. 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 Tohoku Chemical's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Tohoku Chemical 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. During the last three years, Tohoku Chemical burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

Although Tohoku Chemical's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥1.80b. And it impressed us with its EBIT growth of 101% over the last year. So we don't have any problem with Tohoku Chemical's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Tohoku Chemical you should know about.

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. 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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