Is WashhouseLtd (TSE:6537) Using Too Much Debt?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Washhouse Co.,Ltd. (TSE:6537) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for WashhouseLtd

What Is WashhouseLtd's Debt?

As you can see below, WashhouseLtd had JP¥794.0m of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have JP¥1.04b in cash offsetting this, leading to net cash of JP¥241.0m.

How Strong Is WashhouseLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that WashhouseLtd had liabilities of JP¥1.16b due within 12 months and liabilities of JP¥1.10b due beyond that. On the other hand, it had cash of JP¥1.04b and JP¥957.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥265.0m.

Since publicly traded WashhouseLtd shares are worth a total of JP¥2.33b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, WashhouseLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

We also note that WashhouseLtd improved its EBIT from a last year's loss to a positive JP¥21m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is WashhouseLtd'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 company can only pay off debt with cold hard cash, not accounting profits. While WashhouseLtd 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 last year, WashhouseLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although WashhouseLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥241.0m. And it impressed us with free cash flow of JP¥155m, being 738% of its EBIT. So we are not troubled with WashhouseLtd's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with WashhouseLtd .

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.