Is Nova SystemLtd (TSE:5257) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Nova System Co.,Ltd. (TSE:5257) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. 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.

What Is Nova SystemLtd's Debt?

The image below, which you can click on for greater detail, shows that Nova SystemLtd had debt of JP¥628.0m at the end of December 2024, a reduction from JP¥893.0m over a year. But on the other hand it also has JP¥758.0m in cash, leading to a JP¥130.0m net cash position.

How Healthy Is Nova SystemLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Nova SystemLtd had liabilities of JP¥1.04b due within 12 months and liabilities of JP¥454.0m due beyond that. Offsetting this, it had JP¥758.0m in cash and JP¥1.39b in receivables that were due within 12 months. So it can boast JP¥649.0m 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. Simply put, the fact that Nova SystemLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

See our latest analysis for Nova SystemLtd

Fortunately, Nova SystemLtd grew its EBIT by 7.5% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. 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 .

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. Over the last three years, Nova SystemLtd recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case Nova SystemLtd has JP¥130.0m in net cash and a decent-looking balance sheet. And it also grew its EBIT by 7.5% over the last year. So we are not troubled with Nova SystemLtd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Nova SystemLtd is showing 1 warning sign 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.