These 4 Measures Indicate That SmartDrive (TSE:5137) Is Using Debt Extensively

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that SmartDrive inc. (TSE:5137) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. 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.

See our latest analysis for SmartDrive

How Much Debt Does SmartDrive Carry?

The image below, which you can click on for greater detail, shows that SmartDrive had debt of JP¥530.0m at the end of December 2023, a reduction from JP¥630.0m over a year. But on the other hand it also has JP¥907.0m in cash, leading to a JP¥377.0m net cash position.

A Look At SmartDrive's Liabilities

Zooming in on the latest balance sheet data, we can see that SmartDrive had liabilities of JP¥554.0m due within 12 months and liabilities of JP¥531.0m due beyond that. Offsetting this, it had JP¥907.0m in cash and JP¥369.0m in receivables that were due within 12 months. So it can boast JP¥191.0m more liquid assets than total liabilities.

Having regard to SmartDrive's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the JP¥11.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that SmartDrive has more cash than debt is arguably a good indication that it can manage its debt safely.

Notably, SmartDrive made a loss at the EBIT level, last year, but improved that to positive EBIT of JP¥11m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if SmartDrive can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. SmartDrive 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 year, SmartDrive 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 it is always sensible to investigate a company's debt, in this case SmartDrive has JP¥377.0m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about SmartDrive's balance sheet. 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 2 warning signs we've spotted with SmartDrive (including 1 which can't be ignored) .

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.

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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.