Here's Why Koei Tecmo Holdings (TSE:3635) Can Manage Its Debt Responsibly

Warren Buffett famously said, '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 note that Koei Tecmo Holdings Co., Ltd. (TSE:3635) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Koei Tecmo Holdings

What Is Koei Tecmo Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Koei Tecmo Holdings had JP¥55.3b of debt in June 2024, down from JP¥62.1b, one year before. But on the other hand it also has JP¥75.0b in cash, leading to a JP¥19.7b net cash position.

A Look At Koei Tecmo Holdings' Liabilities

The latest balance sheet data shows that Koei Tecmo Holdings had liabilities of JP¥74.3b due within a year, and liabilities of JP¥3.59b falling due after that. Offsetting this, it had JP¥75.0b in cash and JP¥10.9b in receivables that were due within 12 months. So it actually has JP¥7.98b more liquid assets than total liabilities.

This state of affairs indicates that Koei Tecmo Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the JP¥511.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Koei Tecmo Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Koei Tecmo Holdings if management cannot prevent a repeat of the 24% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Koei Tecmo Holdings'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Koei Tecmo Holdings 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. During the last three years, Koei Tecmo Holdings generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Koei Tecmo Holdings has JP¥19.7b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in JP¥35b. So we are not troubled with Koei Tecmo Holdings's debt use. 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. Case in point: We've spotted 1 warning sign for Koei Tecmo Holdings you should be aware of.

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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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.