WashhouseLtd (TSE:6537) Could Easily Take On More 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.' 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, Washhouse Co.,Ltd. (TSE:6537) does carry debt. But the real question is whether this debt is making the company risky.

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What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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.

How Much Debt Does WashhouseLtd Carry?

As you can see below, WashhouseLtd had JP¥754.0m of debt at December 2024, down from JP¥834.0m a year prior. However, it does have JP¥999.0m in cash offsetting this, leading to net cash of JP¥245.0m.

A Look At WashhouseLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that WashhouseLtd had liabilities of JP¥1.21b due within 12 months and liabilities of JP¥1.05b due beyond that. Offsetting these obligations, it had cash of JP¥999.0m as well as receivables valued at JP¥993.0m due within 12 months. So its liabilities total JP¥273.0m more than the combination of its cash and short-term receivables.

Of course, WashhouseLtd has a market capitalization of JP¥2.49b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, WashhouseLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

See our latest analysis for WashhouseLtd

Importantly, WashhouseLtd grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since WashhouseLtd 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 .

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. WashhouseLtd 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. Over the last two years, WashhouseLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

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¥245.0m. And it impressed us with free cash flow of JP¥92m, being 214% of its EBIT. So we don't think WashhouseLtd's use of debt is risky. 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. We've identified 2 warning signs with WashhouseLtd , and understanding them should be part of your investment process.

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.