Does SokenshaLtd (TYO:7413) Have A Healthy Balance Sheet?

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.' 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. Importantly, Sokensha Co.,Ltd. (TYO:7413) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for SokenshaLtd

What Is SokenshaLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 SokenshaLtd had JP¥951.0m of debt, an increase on JP¥772.0m, over one year. But on the other hand it also has JP¥1.46b in cash, leading to a JP¥512.0m net cash position.

A Look At SokenshaLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that SokenshaLtd had liabilities of JP¥1.42b due within 12 months and liabilities of JP¥780.0m due beyond that. Offsetting these obligations, it had cash of JP¥1.46b as well as receivables valued at JP¥945.0m due within 12 months. So it actually has JP¥209.0m more liquid assets than total liabilities.

This surplus suggests that SokenshaLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, SokenshaLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, SokenshaLtd grew its EBIT by 813% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since SokenshaLtd will need earnings to service that debt. 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. SokenshaLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, SokenshaLtd actually produced more free cash flow than EBIT over the last three years. 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 investigate a company's debt, in this case SokenshaLtd has JP¥512.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JP¥103m, being 121% of its EBIT. So we don't think SokenshaLtd's use of debt is risky. 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. Be aware that SokenshaLtd is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

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.

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