These 4 Measures Indicate That Sumitomo Bakelite (TSE:4203) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that Sumitomo Bakelite Company Limited (TSE:4203) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Sumitomo Bakelite

What Is Sumitomo Bakelite's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Sumitomo Bakelite had debt of JP¥48.5b, up from JP¥43.2b in one year. But on the other hand it also has JP¥123.1b in cash, leading to a JP¥74.6b net cash position.

How Strong Is Sumitomo Bakelite's Balance Sheet?

The latest balance sheet data shows that Sumitomo Bakelite had liabilities of JP¥94.3b due within a year, and liabilities of JP¥43.2b falling due after that. Offsetting this, it had JP¥123.1b in cash and JP¥65.0b in receivables that were due within 12 months. So it can boast JP¥50.6b more liquid assets than total liabilities.

This short term liquidity is a sign that Sumitomo Bakelite could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Sumitomo Bakelite has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, Sumitomo Bakelite grew its EBIT by 9.2% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sumitomo Bakelite's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Sumitomo Bakelite 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 most recent three years, Sumitomo Bakelite recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sumitomo Bakelite has net cash of JP¥74.6b, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 9.2% in the last twelve months. So is Sumitomo Bakelite's debt a risk? It doesn't seem so to us. 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. We've identified 1 warning sign with Sumitomo Bakelite , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.

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