ELEMENTS (TSE:5246) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 ELEMENTS, Inc. (TSE:5246) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for ELEMENTS

How Much Debt Does ELEMENTS Carry?

The chart below, which you can click on for greater detail, shows that ELEMENTS had JP¥1.50b in debt in May 2024; about the same as the year before. However, it does have JP¥2.54b in cash offsetting this, leading to net cash of JP¥1.04b.

A Look At ELEMENTS' Liabilities

Zooming in on the latest balance sheet data, we can see that ELEMENTS had liabilities of JP¥986.0m due within 12 months and liabilities of JP¥1.14b due beyond that. On the other hand, it had cash of JP¥2.54b and JP¥327.0m worth of receivables due within a year. So it can boast JP¥739.0m more liquid assets than total liabilities.

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

It was also good to see that despite losing money on the EBIT line last year, ELEMENTS turned things around in the last 12 months, delivering and EBIT of JP¥297m. When analysing debt levels, the balance sheet is the obvious place to start. But it is ELEMENTS'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. ELEMENTS 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, ELEMENTS burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case ELEMENTS has JP¥1.04b in net cash and a decent-looking balance sheet. So we are not troubled with ELEMENTS's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for ELEMENTS (2 are concerning!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.