These 4 Measures Indicate That TOMY Company (TSE:7867) Is Using Debt Safely

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. We can see that TOMY Company, Ltd. (TSE:7867) does use debt in its business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is TOMY Company's Net Debt?

The image below, which you can click on for greater detail, shows that TOMY Company had debt of JP¥5.15b at the end of December 2024, a reduction from JP¥12.5b over a year. But on the other hand it also has JP¥46.7b in cash, leading to a JP¥41.6b net cash position.

A Look At TOMY Company's Liabilities

Zooming in on the latest balance sheet data, we can see that TOMY Company had liabilities of JP¥56.7b due within 12 months and liabilities of JP¥9.54b due beyond that. Offsetting this, it had JP¥46.7b in cash and JP¥43.4b in receivables that were due within 12 months. So it can boast JP¥23.9b more liquid assets than total liabilities.

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

Check out our latest analysis for TOMY Company

On top of that, TOMY Company grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine TOMY Company's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While TOMY Company 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. During the last three years, TOMY Company generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case TOMY Company has JP¥41.6b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JP¥10b, being 81% of its EBIT. So is TOMY Company's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 1 warning sign for TOMY Company that 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.

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.