ForsideLtd (TSE:2330) Takes On Some Risk With Its Use Of Debt

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.' 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 can see that Forside Co.,Ltd. (TSE:2330) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for ForsideLtd

How Much Debt Does ForsideLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 ForsideLtd had JP¥661.0m of debt, an increase on JP¥522.0m, over one year. However, its balance sheet shows it holds JP¥2.12b in cash, so it actually has JP¥1.46b net cash.

How Strong Is ForsideLtd's Balance Sheet?

According to the last reported balance sheet, ForsideLtd had liabilities of JP¥3.37b due within 12 months, and liabilities of JP¥368.0m due beyond 12 months. Offsetting this, it had JP¥2.12b in cash and JP¥1.85b in receivables that were due within 12 months. So it actually has JP¥230.0m more liquid assets than total liabilities.

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

Importantly, ForsideLtd's EBIT fell a jaw-dropping 97% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since ForsideLtd will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. ForsideLtd 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 two years, ForsideLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that ForsideLtd has net cash of JP¥1.46b, as well as more liquid assets than liabilities. Despite the cash, we do find ForsideLtd's EBIT growth rate concerning, so we're not particularly comfortable with the stock. 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. Case in point: We've spotted 3 warning signs for ForsideLtd you should be aware of, and 1 of them can't be ignored.

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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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.