Here's Why Capcom (TSE:9697) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Capcom Co., Ltd. (TSE:9697) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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

View our latest analysis for Capcom

What Is Capcom's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Capcom had JP¥6.96b of debt in December 2024, down from JP¥7.53b, one year before. But on the other hand it also has JP¥124.6b in cash, leading to a JP¥117.6b net cash position.

A Look At Capcom's Liabilities

We can see from the most recent balance sheet that Capcom had liabilities of JP¥31.6b falling due within a year, and liabilities of JP¥16.7b due beyond that. On the other hand, it had cash of JP¥124.6b and JP¥15.3b worth of receivables due within a year. So it can boast JP¥91.5b more liquid assets than total liabilities.

This short term liquidity is a sign that Capcom could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Capcom has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Capcom's saving grace is its low debt levels, because its EBIT has tanked 38% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Capcom's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Capcom 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. In the last three years, Capcom's free cash flow amounted to 45% 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 Capcom has JP¥117.6b in net cash and a decent-looking balance sheet. So we don't have any problem with Capcom's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Capcom's earnings per share history for free.

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.