Is JAICLtd (TSE:7073) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, JAIC Co.,Ltd. (TSE:7073) does carry debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for JAICLtd

What Is JAICLtd's Debt?

The image below, which you can click on for greater detail, shows that JAICLtd had debt of JP¥921.0m at the end of January 2024, a reduction from JP¥1.30b over a year. However, its balance sheet shows it holds JP¥1.09b in cash, so it actually has JP¥172.0m net cash.

A Look At JAICLtd's Liabilities

We can see from the most recent balance sheet that JAICLtd had liabilities of JP¥785.0m falling due within a year, and liabilities of JP¥779.0m due beyond that. On the other hand, it had cash of JP¥1.09b and JP¥352.0m worth of receivables due within a year. So its liabilities total JP¥119.0m more than the combination of its cash and short-term receivables.

Given JAICLtd has a market capitalization of JP¥2.15b, it's hard to believe these liabilities pose much threat. 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, JAICLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that JAICLtd's load is not too heavy, because its EBIT was down 76% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is JAICLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While JAICLtd 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 three years, JAICLtd recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that JAICLtd has JP¥172.0m in net cash. The cherry on top was that in converted 98% of that EBIT to free cash flow, bringing in JP¥96m. So we don't have any problem with JAICLtd's use of debt. 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 instance, we've identified 3 warning signs for JAICLtd that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.