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. As with many other companies Optowide Technologies Co., Ltd. (SHSE:688195) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Optowide Technologies's Debt?
The image below, which you can click on for greater detail, shows that at December 2023 Optowide Technologies had debt of CN¥52.2m, up from CN¥4.91m in one year. But on the other hand it also has CN¥302.3m in cash, leading to a CN¥250.1m net cash position.
How Strong Is Optowide Technologies' Balance Sheet?
According to the last reported balance sheet, Optowide Technologies had liabilities of CN¥137.7m due within 12 months, and liabilities of CN¥36.7m due beyond 12 months. Offsetting this, it had CN¥302.3m in cash and CN¥145.0m in receivables that were due within 12 months. So it can boast CN¥272.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Optowide Technologies could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Optowide Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.
The modesty of its debt load may become crucial for Optowide Technologies if management cannot prevent a repeat of the 31% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Optowide Technologies's ability to maintain a healthy balance sheet going forward. 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 Optowide Technologies 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, Optowide Technologies burned a lot of cash. 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 Optowide Technologies has net cash of CN¥250.1m, as well as more liquid assets than liabilities. So while Optowide Technologies does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Optowide Technologies that 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.