Nippon Computer Dynamics (TYO:4783) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Nippon Computer Dynamics Co., Ltd. (TYO:4783) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 Nippon Computer Dynamics

How Much Debt Does Nippon Computer Dynamics Carry?

The image below, which you can click on for greater detail, shows that Nippon Computer Dynamics had debt of JP¥640.0m at the end of September 2020, a reduction from JP¥1.08b over a year. But on the other hand it also has JP¥3.26b in cash, leading to a JP¥2.62b net cash position.

How Strong Is Nippon Computer Dynamics's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Nippon Computer Dynamics had liabilities of JP¥4.11b due within 12 months and liabilities of JP¥2.97b due beyond that. On the other hand, it had cash of JP¥3.26b and JP¥2.17b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥1.65b.

While this might seem like a lot, it is not so bad since Nippon Computer Dynamics has a market capitalization of JP¥4.37b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Nippon Computer Dynamics also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Nippon Computer Dynamics if management cannot prevent a repeat of the 37% 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Nippon Computer Dynamics's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Nippon Computer Dynamics 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, Nippon Computer Dynamics created free cash flow amounting to 3.5% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

Although Nippon Computer Dynamics's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of JP¥2.62b. So although we see some areas for improvement, we're not too worried about Nippon Computer Dynamics's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Nippon Computer Dynamics is showing 2 warning signs in our investment analysis , 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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