Is SokenshaLtd (TSE:7413) Using Too Much 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.' 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 Sokensha Co.,Ltd. (TSE:7413) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is SokenshaLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 SokenshaLtd had JP¥903.0m of debt, an increase on JP¥848.0m, over one year. However, it does have JP¥1.38b in cash offsetting this, leading to net cash of JP¥473.0m.

How Healthy Is SokenshaLtd's Balance Sheet?

We can see from the most recent balance sheet that SokenshaLtd had liabilities of JP¥1.49b falling due within a year, and liabilities of JP¥751.0m due beyond that. Offsetting this, it had JP¥1.38b in cash and JP¥999.0m in receivables that were due within 12 months. So it actually has JP¥132.0m more liquid assets than total liabilities.

This short term liquidity is a sign that SokenshaLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, SokenshaLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Check out our latest analysis for SokenshaLtd

Even more impressive was the fact that SokenshaLtd grew its EBIT by 132% over twelve months. That boost will make it even easier to pay down debt going forward. 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While SokenshaLtd 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. Considering the last three years, SokenshaLtd actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case SokenshaLtd has JP¥473.0m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 132% over the last year. So is SokenshaLtd's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for SokenshaLtd (1 is concerning!) that you should be aware of before investing here.

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.