Aucfan (TSE:3674) Seems To Use Debt Rather Sparingly

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.' 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. We note that Aucfan Co., Ltd. (TSE:3674) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Aucfan

What Is Aucfan's Net Debt?

As you can see below, Aucfan had JP¥1.17b of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds JP¥3.35b in cash, so it actually has JP¥2.18b net cash.

A Look At Aucfan's Liabilities

Zooming in on the latest balance sheet data, we can see that Aucfan had liabilities of JP¥2.22b due within 12 months and liabilities of JP¥194.0m due beyond that. On the other hand, it had cash of JP¥3.35b and JP¥2.40b worth of receivables due within a year. So it actually has JP¥3.34b more liquid assets than total liabilities.

This excess liquidity is a great indication that Aucfan's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Aucfan boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Aucfan grew its EBIT by 35% over the last twelve months, and that growth will make it easier to handle its debt. 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 Aucfan will need earnings to service that debt. 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 Aucfan 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. During the last two years, Aucfan produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Aucfan has net cash of JP¥2.18b, as well as more liquid assets than liabilities. And we liked the look of last year's 35% year-on-year EBIT growth. When it comes to Aucfan's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. For example Aucfan has 4 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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.