Is BroadBand Security (TYO:4398) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that BroadBand Security, Inc. (TYO:4398) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for BroadBand Security

How Much Debt Does BroadBand Security Carry?

As you can see below, at the end of December 2020, BroadBand Security had JP¥324.0m of debt, up from JP¥256.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds JP¥693.0m in cash, so it actually has JP¥369.0m net cash.

How Healthy Is BroadBand Security's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that BroadBand Security had liabilities of JP¥1.13b due within 12 months and liabilities of JP¥569.0m due beyond that. On the other hand, it had cash of JP¥693.0m and JP¥576.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥425.0m.

Given BroadBand Security has a market capitalization of JP¥8.17b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, BroadBand Security also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, BroadBand Security grew its EBIT by 69% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is BroadBand Security'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, a company can only pay off debt with cold hard cash, not accounting profits. BroadBand Security 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. Over the last three years, BroadBand Security actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that BroadBand Security has JP¥369.0m in net cash. The cherry on top was that in converted 114% of that EBIT to free cash flow, bringing in JP¥419m. So we don't think BroadBand Security's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for BroadBand Security you should know about.

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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