Computer Engineering & Consulting (TSE:9692) Seems To Use Debt Rather Sparingly

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 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 Computer Engineering & Consulting Ltd. (TSE:9692) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 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.

Check out our latest analysis for Computer Engineering & Consulting

What Is Computer Engineering & Consulting's Net Debt?

The chart below, which you can click on for greater detail, shows that Computer Engineering & Consulting had JP¥363.0m in debt in January 2024; about the same as the year before. However, it does have JP¥26.7b in cash offsetting this, leading to net cash of JP¥26.4b.

How Healthy Is Computer Engineering & Consulting's Balance Sheet?

We can see from the most recent balance sheet that Computer Engineering & Consulting had liabilities of JP¥9.01b falling due within a year, and liabilities of JP¥1.60b due beyond that. Offsetting these obligations, it had cash of JP¥26.7b as well as receivables valued at JP¥10.4b due within 12 months. So it can boast JP¥26.5b more liquid assets than total liabilities.

This surplus liquidity suggests that Computer Engineering & Consulting's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Computer Engineering & Consulting has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Computer Engineering & Consulting grew its EBIT by 45% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Computer Engineering & Consulting can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Computer Engineering & Consulting 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 most recent three years, Computer Engineering & Consulting recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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 Computer Engineering & Consulting has JP¥26.4b in net cash and a decent-looking balance sheet. And we liked the look of last year's 45% year-on-year EBIT growth. So we don't think Computer Engineering & Consulting's use of debt is risky. 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. For example - Computer Engineering & Consulting has 1 warning sign we think you should be aware of.

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.