We Think CAVE InteractiveLTD (TSE:3760) Can Manage Its Debt With Ease

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.' 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. Importantly, CAVE Interactive CO.,LTD. (TSE:3760) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for CAVE InteractiveLTD

What Is CAVE InteractiveLTD's Debt?

You can click the graphic below for the historical numbers, but it shows that CAVE InteractiveLTD had JP¥983.0m of debt in May 2024, down from JP¥1.09b, one year before. However, it does have JP¥6.34b in cash offsetting this, leading to net cash of JP¥5.36b.

How Healthy Is CAVE InteractiveLTD's Balance Sheet?

According to the last reported balance sheet, CAVE InteractiveLTD had liabilities of JP¥3.03b due within 12 months, and liabilities of JP¥4.55b due beyond 12 months. Offsetting this, it had JP¥6.34b in cash and JP¥1.69b in receivables that were due within 12 months. So it can boast JP¥454.0m more liquid assets than total liabilities.

This surplus suggests that CAVE InteractiveLTD has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that CAVE InteractiveLTD has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, CAVE InteractiveLTD grew its EBIT by 892% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is CAVE InteractiveLTD's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While CAVE InteractiveLTD 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. In the last two years, CAVE InteractiveLTD's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case CAVE InteractiveLTD has JP¥5.36b in net cash and a decent-looking balance sheet. And we liked the look of last year's 892% year-on-year EBIT growth. So is CAVE InteractiveLTD's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for CAVE InteractiveLTD (of which 1 makes us a bit uncomfortable!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.