Is ForsideLtd (TSE:2330) Using Too Much Debt?

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. Importantly, Forside Co.,Ltd. (TSE:2330) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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

See our latest analysis for ForsideLtd

How Much Debt Does ForsideLtd Carry?

The image below, which you can click on for greater detail, shows that ForsideLtd had debt of JP¥497.0m at the end of December 2023, a reduction from JP¥712.0m over a year. However, its balance sheet shows it holds JP¥1.19b in cash, so it actually has JP¥693.0m net cash.

How Strong Is ForsideLtd's Balance Sheet?

According to the last reported balance sheet, ForsideLtd had liabilities of JP¥2.46b due within 12 months, and liabilities of JP¥412.0m due beyond 12 months. On the other hand, it had cash of JP¥1.19b and JP¥1.65b worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to ForsideLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the JP¥14.3b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, ForsideLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, ForsideLtd turned things around in the last 12 months, delivering and EBIT of JP¥53m. There's no doubt that we learn most about debt from the balance sheet. But it is ForsideLtd'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. During the last year, ForsideLtd generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

We could understand if investors are concerned about ForsideLtd's liabilities, but we can be reassured by the fact it has has net cash of JP¥693.0m. The cherry on top was that in converted 87% of that EBIT to free cash flow, bringing in JP¥46m. So is ForsideLtd's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 4 warning signs for ForsideLtd (1 is a bit unpleasant) you should be aware of.

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.

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.