Is Bank of InnovationInc (TSE:4393) Using Too Much Debt?

Warren Buffett famously said, '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. We can see that Bank of Innovation,Inc. (TSE:4393) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Bank of InnovationInc

What Is Bank of InnovationInc's Net Debt?

As you can see below, Bank of InnovationInc had JP¥346.0m of debt at March 2024, down from JP¥764.0m a year prior. But it also has JP¥4.28b in cash to offset that, meaning it has JP¥3.93b net cash.

How Healthy Is Bank of InnovationInc's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Bank of InnovationInc had liabilities of JP¥2.38b due within 12 months and liabilities of JP¥229.0m due beyond that. On the other hand, it had cash of JP¥4.28b and JP¥2.07b worth of receivables due within a year. So it actually has JP¥3.73b more liquid assets than total liabilities.

This surplus suggests that Bank of InnovationInc is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Bank of InnovationInc has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Bank of InnovationInc if management cannot prevent a repeat of the 54% 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 you can't view debt in total isolation; since Bank of InnovationInc 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Bank of InnovationInc 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 two years, Bank of InnovationInc produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

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¥3.93b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of JP¥1.4b, being 67% of its EBIT. So we don't have any problem with Bank of InnovationInc's use of debt. 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. For instance, we've identified 2 warning signs for Bank of InnovationInc (1 is a bit concerning) 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.

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