Is Bank of InnovationInc (TSE:4393) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Bank of Innovation,Inc. (TSE:4393) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Bank of InnovationInc

What Is Bank of InnovationInc's Debt?

The image below, which you can click on for greater detail, shows that Bank of InnovationInc had debt of JP¥263.0m at the end of June 2024, a reduction from JP¥657.0m over a year. But it also has JP¥3.42b in cash to offset that, meaning it has JP¥3.16b net cash.

A Look At Bank of InnovationInc's Liabilities

The latest balance sheet data shows that Bank of InnovationInc had liabilities of JP¥1.45b due within a year, and liabilities of JP¥168.0m falling due after that. Offsetting these obligations, it had cash of JP¥3.42b as well as receivables valued at JP¥1.66b due within 12 months. So it actually has JP¥3.47b more liquid assets than total liabilities.

This excess liquidity suggests that Bank of InnovationInc is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Bank of InnovationInc 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 Bank of InnovationInc if management cannot prevent a repeat of the 67% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Bank of InnovationInc's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Bank of InnovationInc 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. Over the last two years, Bank of InnovationInc recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Bank of InnovationInc has net cash of JP¥3.16b, as well as more liquid assets than liabilities. The cherry on top was that in converted 87% of that EBIT to free cash flow, bringing in JP¥1.4b. So we don't think Bank of InnovationInc's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Bank of InnovationInc (including 1 which shouldn't be ignored) .

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.