We Think Sun A.Kaken CompanyLimited (TSE:4234) Can Stay On Top Of Its Debt

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.' 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 can see that Sun A.Kaken Company,Limited (TSE:4234) does use debt in its business. But the real question is whether this debt is making the company risky.

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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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

How Much Debt Does Sun A.Kaken CompanyLimited Carry?

The image below, which you can click on for greater detail, shows that at December 2024 Sun A.Kaken CompanyLimited had debt of JP¥5.19b, up from JP¥4.30b in one year. However, it does have JP¥6.70b in cash offsetting this, leading to net cash of JP¥1.51b.

How Healthy Is Sun A.Kaken CompanyLimited's Balance Sheet?

According to the last reported balance sheet, Sun A.Kaken CompanyLimited had liabilities of JP¥13.8b due within 12 months, and liabilities of JP¥3.64b due beyond 12 months. Offsetting this, it had JP¥6.70b in cash and JP¥11.1b in receivables that were due within 12 months. So it can boast JP¥378.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Sun A.Kaken CompanyLimited could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Sun A.Kaken CompanyLimited has more cash than debt is arguably a good indication that it can manage its debt safely.

View our latest analysis for Sun A.Kaken CompanyLimited

Although Sun A.Kaken CompanyLimited made a loss at the EBIT level, last year, it was also good to see that it generated JP¥1.0m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sun A.Kaken CompanyLimited 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sun A.Kaken CompanyLimited 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 last year, Sun A.Kaken CompanyLimited saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sun A.Kaken CompanyLimited has net cash of JP¥1.51b, as well as more liquid assets than liabilities. So we don't have any problem with Sun A.Kaken CompanyLimited's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Sun A.Kaken CompanyLimited is showing 3 warning signs in our investment analysis , 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.