Soken Chemical & Engineering (TSE:4972) Has A Rock Solid Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Soken Chemical & Engineering Co., Ltd. (TSE:4972) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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.

Check out our latest analysis for Soken Chemical & Engineering

What Is Soken Chemical & Engineering's Debt?

As you can see below, at the end of September 2024, Soken Chemical & Engineering had JP¥5.00b of debt, up from JP¥4.58b a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥14.4b in cash, so it actually has JP¥9.44b net cash.

A Look At Soken Chemical & Engineering's Liabilities

According to the last reported balance sheet, Soken Chemical & Engineering had liabilities of JP¥15.1b due within 12 months, and liabilities of JP¥3.67b due beyond 12 months. On the other hand, it had cash of JP¥14.4b and JP¥12.5b worth of receivables due within a year. So it actually has JP¥8.16b more liquid assets than total liabilities.

This excess liquidity suggests that Soken Chemical & Engineering is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Soken Chemical & Engineering has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Soken Chemical & Engineering grew its EBIT by 127% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Soken Chemical & Engineering'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Soken Chemical & Engineering 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. Looking at the most recent three years, Soken Chemical & Engineering recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Soken Chemical & Engineering has net cash of JP¥9.44b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 127% over the last year. So we don't think Soken Chemical & Engineering'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. For instance, we've identified 1 warning sign for Soken Chemical & Engineering that you should be aware of.

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.