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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Japan Animal Referral Medical Center Co., Ltd. (TSE:6039) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Japan Animal Referral Medical Center's Debt?
As you can see below, Japan Animal Referral Medical Center had JP¥3.64b of debt at December 2024, down from JP¥4.01b a year prior. On the flip side, it has JP¥1.03b in cash leading to net debt of about JP¥2.62b.
How Strong Is Japan Animal Referral Medical Center's Balance Sheet?
According to the last reported balance sheet, Japan Animal Referral Medical Center had liabilities of JP¥1.39b due within 12 months, and liabilities of JP¥3.20b due beyond 12 months. Offsetting this, it had JP¥1.03b in cash and JP¥333.6m in receivables that were due within 12 months. So its liabilities total JP¥3.23b more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Japan Animal Referral Medical Center is worth JP¥6.19b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
Check out our latest analysis for Japan Animal Referral Medical Center
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Japan Animal Referral Medical Center's net debt to EBITDA ratio of about 2.1 suggests only moderate use of debt. And its strong interest cover of 31.6 times, makes us even more comfortable. It is well worth noting that Japan Animal Referral Medical Center's EBIT shot up like bamboo after rain, gaining 58% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Japan Animal Referral Medical Center'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Japan Animal Referral Medical Center recorded negative free cash flow, in total. 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.
Our View
Japan Animal Referral Medical Center's interest cover was a real positive on this analysis, as was its EBIT growth rate. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. It's also worth noting that Japan Animal Referral Medical Center is in the Healthcare industry, which is often considered to be quite defensive. Considering this range of data points, we think Japan Animal Referral Medical Center is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Japan Animal Referral Medical Center you should know about.
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.