Scala (TSE:4845) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Scala, Inc. (TSE:4845) does use debt in its business. But the real question is whether this debt is making the company risky.

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When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

What Is Scala's Debt?

The image below, which you can click on for greater detail, shows that Scala had debt of JP¥4.48b at the end of December 2024, a reduction from JP¥6.34b over a year. But on the other hand it also has JP¥5.63b in cash, leading to a JP¥1.15b net cash position.

How Healthy Is Scala's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Scala had liabilities of JP¥4.71b due within 12 months and liabilities of JP¥2.66b due beyond that. Offsetting these obligations, it had cash of JP¥5.63b as well as receivables valued at JP¥1.43b due within 12 months. So its liabilities total JP¥303.0m more than the combination of its cash and short-term receivables.

Since publicly traded Scala shares are worth a total of JP¥6.82b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Scala also has more cash than debt, so we're pretty confident it can manage its debt safely.

View our latest analysis for Scala

Although Scala made a loss at the EBIT level, last year, it was also good to see that it generated JP¥129m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Scala will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot .

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Scala 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 most recent year, Scala recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Scala's liabilities, but we can be reassured by the fact it has has net cash of JP¥1.15b. And it impressed us with free cash flow of JP¥90m, being 70% of its EBIT. So we don't think Scala's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Scala (including 2 which are a bit concerning) .

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.