Kyoritsu Electric (TYO:6874) Has A Rock Solid Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Kyoritsu Electric Corporation (TYO:6874) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Kyoritsu Electric

What Is Kyoritsu Electric's Net Debt?

The chart below, which you can click on for greater detail, shows that Kyoritsu Electric had JP¥1.70b in debt in December 2020; about the same as the year before. But it also has JP¥4.92b in cash to offset that, meaning it has JP¥3.22b net cash.

How Strong Is Kyoritsu Electric's Balance Sheet?

The latest balance sheet data shows that Kyoritsu Electric had liabilities of JP¥7.68b due within a year, and liabilities of JP¥2.22b falling due after that. Offsetting this, it had JP¥4.92b in cash and JP¥9.13b in receivables that were due within 12 months. So it actually has JP¥4.14b more liquid assets than total liabilities.

This surplus liquidity suggests that Kyoritsu Electric's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Kyoritsu Electric boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Kyoritsu Electric's saving grace is its low debt levels, because its EBIT has tanked 23% in the last twelve months. 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 Kyoritsu Electric will need earnings to service that debt. 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 Kyoritsu Electric 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, Kyoritsu Electric generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case Kyoritsu Electric has JP¥3.22b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JP¥2.5b, being 82% of its EBIT. So we don't think Kyoritsu Electric's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Kyoritsu Electric 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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