These 4 Measures Indicate That Echo Trading (TSE:7427) Is Using Debt Safely

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. We can see that Echo Trading Co., Ltd. (TSE:7427) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Echo Trading

What Is Echo Trading's Debt?

As you can see below, Echo Trading had JP¥3.50b of debt at May 2024, down from JP¥4.80b a year prior. But on the other hand it also has JP¥4.05b in cash, leading to a JP¥548.0m net cash position.

How Strong Is Echo Trading's Balance Sheet?

The latest balance sheet data shows that Echo Trading had liabilities of JP¥24.9b due within a year, and liabilities of JP¥321.0m falling due after that. Offsetting this, it had JP¥4.05b in cash and JP¥25.3b in receivables that were due within 12 months. So it actually has JP¥4.15b more liquid assets than total liabilities.

This luscious liquidity implies that Echo Trading's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Echo Trading has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Echo Trading has been able to increase its EBIT by 30% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Echo Trading's earnings that will influence how the balance sheet holds up in the future. 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. Echo Trading 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. In the last three years, Echo Trading's free cash flow amounted to 36% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Echo Trading has net cash of JP¥548.0m, as well as more liquid assets than liabilities. And we liked the look of last year's 30% year-on-year EBIT growth. So we don't think Echo Trading's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Echo Trading has 1 warning sign we think you should be aware of.

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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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.