These 4 Measures Indicate That AR advanced technology (TSE:5578) Is Using Debt Reasonably Well

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.' 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 note that AR advanced technology, Inc. (TSE:5578) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for AR advanced technology

What Is AR advanced technology's Net Debt?

The chart below, which you can click on for greater detail, shows that AR advanced technology had JP¥880.0m in debt in August 2024; about the same as the year before. But on the other hand it also has JP¥2.33b in cash, leading to a JP¥1.45b net cash position.

A Look At AR advanced technology's Liabilities

We can see from the most recent balance sheet that AR advanced technology had liabilities of JP¥2.76b falling due within a year, and liabilities of JP¥22.0m due beyond that. Offsetting this, it had JP¥2.33b in cash and JP¥1.55b in receivables that were due within 12 months. So it can boast JP¥1.10b more liquid assets than total liabilities.

This surplus suggests that AR advanced technology is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that AR advanced technology has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that AR advanced technology's load is not too heavy, because its EBIT was down 20% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since AR advanced technology will need earnings to service that debt. 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, a company can only pay off debt with cold hard cash, not accounting profits. While AR advanced technology 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. During the last three years, AR advanced technology produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case AR advanced technology has JP¥1.45b in net cash and a decent-looking balance sheet. So we are not troubled with AR advanced technology's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example AR advanced technology has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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.