Does Nippon Ichi Software (TYO:3851) Have A Healthy Balance Sheet?

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 can see that Nippon Ichi Software, Inc. (TYO:3851) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Nippon Ichi Software

How Much Debt Does Nippon Ichi Software Carry?

As you can see below, Nippon Ichi Software had JP¥367.0m of debt at December 2020, down from JP¥520.0m a year prior. However, its balance sheet shows it holds JP¥3.26b in cash, so it actually has JP¥2.90b net cash.

How Healthy Is Nippon Ichi Software's Balance Sheet?

The latest balance sheet data shows that Nippon Ichi Software had liabilities of JP¥1.26b due within a year, and liabilities of JP¥332.0m falling due after that. Offsetting these obligations, it had cash of JP¥3.26b as well as receivables valued at JP¥359.0m due within 12 months. So it can boast JP¥2.03b more liquid assets than total liabilities.

This excess liquidity is a great indication that Nippon Ichi Software's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Nippon Ichi Software boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Nippon Ichi Software grew its EBIT by 2,012% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Nippon Ichi Software will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Nippon Ichi Software 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, Nippon Ichi Software recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Nippon Ichi Software has net cash of JP¥2.90b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 2,012% over the last year. So is Nippon Ichi Software's debt a risk? It doesn't seem so to us. 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. We've identified 1 warning sign with Nippon Ichi Software , and understanding them should be part of your investment process.

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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