Sohgo Security ServicesLtd (TSE:2331) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Sohgo Security Services Co.,Ltd. (TSE:2331) makes use of debt. But the real question is whether this debt is making the company risky.

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Sohgo Security ServicesLtd

What Is Sohgo Security ServicesLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Sohgo Security ServicesLtd had debt of JP¥16.4b, up from JP¥11.6b in one year. However, its balance sheet shows it holds JP¥146.5b in cash, so it actually has JP¥130.1b net cash.

How Healthy Is Sohgo Security ServicesLtd's Balance Sheet?

We can see from the most recent balance sheet that Sohgo Security ServicesLtd had liabilities of JP¥105.4b falling due within a year, and liabilities of JP¥80.4b due beyond that. On the other hand, it had cash of JP¥146.5b and JP¥59.8b worth of receivables due within a year. So it can boast JP¥20.4b more liquid assets than total liabilities.

This surplus suggests that Sohgo Security ServicesLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Sohgo Security ServicesLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Sohgo Security ServicesLtd saw its EBIT decline by 2.2% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sohgo Security ServicesLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sohgo Security ServicesLtd 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, Sohgo Security ServicesLtd recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sohgo Security ServicesLtd has net cash of JP¥130.1b, as well as more liquid assets than liabilities. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in JP¥38b. So is Sohgo Security ServicesLtd's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Sohgo Security ServicesLtd, you may well want to click here to check an interactive graph of its earnings per share history.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.