Does Kyoei Security Service (TYO:7058) 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.' 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, Kyoei Security Service Co., Ltd. (TYO:7058) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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, 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.

View our latest analysis for Kyoei Security Service

What Is Kyoei Security Service's Debt?

As you can see below, at the end of December 2020, Kyoei Security Service had JP¥458.0m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥3.10b in cash, so it actually has JP¥2.64b net cash.

How Strong Is Kyoei Security Service's Balance Sheet?

The latest balance sheet data shows that Kyoei Security Service had liabilities of JP¥833.0m due within a year, and liabilities of JP¥383.0m falling due after that. Offsetting these obligations, it had cash of JP¥3.10b as well as receivables valued at JP¥673.0m due within 12 months. So it actually has JP¥2.55b more liquid assets than total liabilities.

This excess liquidity is a great indication that Kyoei Security Service's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Kyoei Security Service boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Kyoei Security Service has seen its EBIT plunge 13% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Kyoei Security Service'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 Kyoei Security Service 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. In the last three years, Kyoei Security Service's free cash flow amounted to 49% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kyoei Security Service has net cash of JP¥2.64b, as well as more liquid assets than liabilities. So we don't think Kyoei Security Service's use of debt is risky. 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. For example - Kyoei Security Service has 2 warning signs we think you should be aware of.

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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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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