Here's Why Cross Cat (TSE:2307) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Cross Cat Co., Ltd. (TSE:2307) does carry debt. 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. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Cross Cat

What Is Cross Cat's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Cross Cat had JP¥1.20b of debt, an increase on JP¥700.0m, over one year. But on the other hand it also has JP¥2.64b in cash, leading to a JP¥1.44b net cash position.

How Healthy Is Cross Cat's Balance Sheet?

We can see from the most recent balance sheet that Cross Cat had liabilities of JP¥2.89b falling due within a year, and liabilities of JP¥990.0m due beyond that. On the other hand, it had cash of JP¥2.64b and JP¥3.66b worth of receivables due within a year. So it actually has JP¥2.42b more liquid assets than total liabilities.

This surplus suggests that Cross Cat has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Cross Cat boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Cross Cat saw its EBIT drop by 9.8% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Cross Cat'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Cross Cat 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 three years, Cross Cat produced sturdy free cash flow equating to 59% 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 Cross Cat has net cash of JP¥1.44b, as well as more liquid assets than liabilities. So we don't have any problem with Cross Cat's use of debt. 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. We've identified 2 warning signs with Cross Cat , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.