Does Nova SystemLtd (TSE:5257) Have A 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.' 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. We can see that Nova System Co.,Ltd. (TSE:5257) does use debt in its business. But should shareholders be worried about its use of debt?

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What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Nova SystemLtd's Debt?

The chart below, which you can click on for greater detail, shows that Nova SystemLtd had JP¥920.0m in debt in March 2025; about the same as the year before. But it also has JP¥1.26b in cash to offset that, meaning it has JP¥336.0m net cash.

A Look At Nova SystemLtd's Liabilities

The latest balance sheet data shows that Nova SystemLtd had liabilities of JP¥1.11b due within a year, and liabilities of JP¥618.0m falling due after that. Offsetting these obligations, it had cash of JP¥1.26b as well as receivables valued at JP¥1.13b due within 12 months. So it actually has JP¥662.0m more liquid assets than total liabilities.

This surplus suggests that Nova SystemLtd is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Nova SystemLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Check out our latest analysis for Nova SystemLtd

But the other side of the story is that Nova SystemLtd saw its EBIT decline by 3.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Nova SystemLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Nova SystemLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Nova SystemLtd created free cash flow amounting to 5.3% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Nova SystemLtd has net cash of JP¥336.0m, as well as more liquid assets than liabilities. So we are not troubled with Nova SystemLtd's debt use. 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. Be aware that Nova SystemLtd is showing 2 warning signs in our investment analysis , you should know about...

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.