Is Arakawa Chemical Industries (TSE:4968) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that Arakawa Chemical Industries, Ltd. (TSE:4968) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Arakawa Chemical Industries

How Much Debt Does Arakawa Chemical Industries Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Arakawa Chemical Industries had debt of JP¥41.3b, up from JP¥37.1b in one year. However, because it has a cash reserve of JP¥9.82b, its net debt is less, at about JP¥31.5b.

A Look At Arakawa Chemical Industries' Liabilities

Zooming in on the latest balance sheet data, we can see that Arakawa Chemical Industries had liabilities of JP¥40.3b due within 12 months and liabilities of JP¥24.7b due beyond that. Offsetting these obligations, it had cash of JP¥9.82b as well as receivables valued at JP¥29.1b due within 12 months. So it has liabilities totalling JP¥26.2b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's JP¥23.6b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Arakawa Chemical Industries's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Arakawa Chemical Industries saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

Caveat Emptor

Importantly, Arakawa Chemical Industries had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at JP¥1.2b. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through JP¥4.4b in negative free cash flow over the last year. That means it's on the risky side of things. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Arakawa Chemical Industries (1 is significant!) that you should be aware of before investing here.

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.