We Think Innovation (TSE:3970) Can Manage Its Debt With Ease

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Innovation Inc. (TSE:3970) does carry debt. But is this debt a concern to shareholders?

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Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Innovation's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Innovation had JP¥224.0m of debt, an increase on none, over one year. However, it does have JP¥2.95b in cash offsetting this, leading to net cash of JP¥2.73b.

How Healthy Is Innovation's Balance Sheet?

We can see from the most recent balance sheet that Innovation had liabilities of JP¥692.0m falling due within a year, and liabilities of JP¥157.0m due beyond that. Offsetting this, it had JP¥2.95b in cash and JP¥790.0m in receivables that were due within 12 months. So it actually has JP¥2.89b more liquid assets than total liabilities.

This luscious liquidity implies that Innovation's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Innovation has more cash than debt is arguably a good indication that it can manage its debt safely.

Check out our latest analysis for Innovation

Also positive, Innovation grew its EBIT by 20% in the last year, and that should make it 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 Innovation'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 .

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Innovation 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. Looking at the most recent three years, Innovation recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Innovation has JP¥2.73b in net cash and a strong balance sheet. And it impressed us with its EBIT growth of 20% over the last year. So is Innovation's debt a risk? It doesn't seem so to us. 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. Be aware that Innovation is showing 2 warning signs in our investment analysis , and 1 of those is significant...

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.

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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.