Does Kossan Rubber Industries Bhd (KLSE:KOSSAN) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 can see that Kossan Rubber Industries Bhd (KLSE:KOSSAN) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Kossan Rubber Industries Bhd

How Much Debt Does Kossan Rubber Industries Bhd Carry?

You can click the graphic below for the historical numbers, but it shows that Kossan Rubber Industries Bhd had RM304.8m of debt in September 2021, down from RM511.7m, one year before. But on the other hand it also has RM2.71b in cash, leading to a RM2.40b net cash position.

How Strong Is Kossan Rubber Industries Bhd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kossan Rubber Industries Bhd had liabilities of RM1.11b due within 12 months and liabilities of RM220.8m due beyond that. Offsetting these obligations, it had cash of RM2.71b as well as receivables valued at RM927.2m due within 12 months. So it actually has RM2.30b more liquid assets than total liabilities.

This surplus strongly suggests that Kossan Rubber Industries Bhd has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Kossan Rubber Industries Bhd has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Kossan Rubber Industries Bhd grew its EBIT by 458% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Kossan Rubber Industries Bhd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Kossan Rubber Industries Bhd 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, Kossan Rubber Industries Bhd produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kossan Rubber Industries Bhd has net cash of RM2.40b, as well as more liquid assets than liabilities. And we liked the look of last year's 458% year-on-year EBIT growth. At the end of the day we're not concerned about Kossan Rubber Industries Bhd's debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Kossan Rubber Industries Bhd has 3 warning signs (and 1 which makes us a bit uncomfortable) we think 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.