Persol HoldingsLtd (TSE:2181) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Persol Holdings Co.,Ltd. (TSE:2181) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Persol HoldingsLtd

What Is Persol HoldingsLtd's Debt?

As you can see below, Persol HoldingsLtd had JP¥20.3b of debt at June 2024, down from JP¥60.0b a year prior. But it also has JP¥82.8b in cash to offset that, meaning it has JP¥62.5b net cash.

How Healthy Is Persol HoldingsLtd's Balance Sheet?

According to the last reported balance sheet, Persol HoldingsLtd had liabilities of JP¥258.7b due within 12 months, and liabilities of JP¥53.1b due beyond 12 months. Offsetting these obligations, it had cash of JP¥82.8b as well as receivables valued at JP¥175.1b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥53.9b.

Of course, Persol HoldingsLtd has a market capitalization of JP¥572.0b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Persol HoldingsLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Persol HoldingsLtd grew its EBIT at 11% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Persol HoldingsLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Persol HoldingsLtd 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. Over the last three years, Persol HoldingsLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Persol HoldingsLtd has JP¥62.5b in net cash. The cherry on top was that in converted 106% of that EBIT to free cash flow, bringing in JP¥82b. So is Persol HoldingsLtd's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Persol HoldingsLtd , and understanding them should be part of your investment process.

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. 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.