Here's Why Kaga ElectronicsLtd (TSE:8154) Can Manage Its Debt Responsibly

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 Kaga Electronics Co.,Ltd. (TSE:8154) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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.

View our latest analysis for Kaga ElectronicsLtd

How Much Debt Does Kaga ElectronicsLtd Carry?

The image below, which you can click on for greater detail, shows that Kaga ElectronicsLtd had debt of JP¥40.8b at the end of December 2023, a reduction from JP¥51.1b over a year. But it also has JP¥63.7b in cash to offset that, meaning it has JP¥22.9b net cash.

How Strong Is Kaga ElectronicsLtd's Balance Sheet?

We can see from the most recent balance sheet that Kaga ElectronicsLtd had liabilities of JP¥114.3b falling due within a year, and liabilities of JP¥30.9b due beyond that. Offsetting these obligations, it had cash of JP¥63.7b as well as receivables valued at JP¥108.4b due within 12 months. So it actually has JP¥26.9b more liquid assets than total liabilities.

It's good to see that Kaga ElectronicsLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Kaga ElectronicsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Kaga ElectronicsLtd has seen its EBIT plunge 17% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Kaga ElectronicsLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Kaga ElectronicsLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Kaga ElectronicsLtd recorded free cash flow worth 57% 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 we empathize with investors who find debt concerning, you should keep in mind that Kaga ElectronicsLtd has net cash of JP¥22.9b, as well as more liquid assets than liabilities. So we don't have any problem with Kaga ElectronicsLtd's use of debt. 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. For instance, we've identified 1 warning sign for Kaga ElectronicsLtd that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.