Does AINAVO HOLDINGSLtd (TYO:7539) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies AINAVO HOLDINGS Co.,Ltd. (TYO:7539) makes use of debt. But should shareholders be worried about its use of debt?

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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for AINAVO HOLDINGSLtd

What Is AINAVO HOLDINGSLtd's Debt?

The image below, which you can click on for greater detail, shows that AINAVO HOLDINGSLtd had debt of JP¥388.0m at the end of December 2020, a reduction from JP¥603.0m over a year. But on the other hand it also has JP¥11.0b in cash, leading to a JP¥10.6b net cash position.

A Look At AINAVO HOLDINGSLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that AINAVO HOLDINGSLtd had liabilities of JP¥13.1b due within 12 months and liabilities of JP¥1.33b due beyond that. Offsetting these obligations, it had cash of JP¥11.0b as well as receivables valued at JP¥11.6b due within 12 months. So it actually has JP¥8.13b more liquid assets than total liabilities.

This luscious liquidity implies that AINAVO HOLDINGSLtd's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that AINAVO HOLDINGSLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that AINAVO HOLDINGSLtd has seen its EBIT plunge 14% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is AINAVO HOLDINGSLtd'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, a company can only pay off debt with cold hard cash, not accounting profits. While AINAVO 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 most recent three years, AINAVO HOLDINGSLtd recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case AINAVO HOLDINGSLtd has JP¥10.6b in net cash and a decent-looking balance sheet. So we don't think AINAVO HOLDINGSLtd's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for AINAVO HOLDINGSLtd you should be aware of.

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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