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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Insigma Technology Co., Ltd. (SHSE:600797) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Insigma Technology's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Insigma Technology had debt of CN¥801.3m, up from CN¥714.8m in one year. However, it also had CN¥772.9m in cash, and so its net debt is CN¥28.4m.
A Look At Insigma Technology's Liabilities
We can see from the most recent balance sheet that Insigma Technology had liabilities of CN¥1.43b falling due within a year, and liabilities of CN¥799.4m due beyond that. On the other hand, it had cash of CN¥772.9m and CN¥1.22b worth of receivables due within a year. So its liabilities total CN¥233.8m more than the combination of its cash and short-term receivables.
Since publicly traded Insigma Technology shares are worth a total of CN¥5.05b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, Insigma Technology has virtually no net debt, so it's fair to say it does not have a heavy debt load! 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 Insigma Technology will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
In the last year Insigma Technology had a loss before interest and tax, and actually shrunk its revenue by 14%, to CN¥3.7b. We would much prefer see growth.
Caveat Emptor
Not only did Insigma Technology's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥7.9m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of CN¥91m and the profit of CN¥69m. So one might argue that there's still a chance it can get things on the right track. 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. Case in point: We've spotted 2 warning signs for Insigma Technology you should be aware of, and 1 of them is a bit unpleasant.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.