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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Chinasoft International Limited (HKG:354) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Chinasoft International Carry?
The image below, which you can click on for greater detail, shows that at December 2023 Chinasoft International had debt of CN¥3.02b, up from CN¥1.93b in one year. But on the other hand it also has CN¥4.68b in cash, leading to a CN¥1.66b net cash position.
How Strong Is Chinasoft International's Balance Sheet?
According to the last reported balance sheet, Chinasoft International had liabilities of CN¥2.96b due within 12 months, and liabilities of CN¥2.34b due beyond 12 months. On the other hand, it had cash of CN¥4.68b and CN¥7.58b worth of receivables due within a year. So it can boast CN¥6.96b more liquid assets than total liabilities.
This surplus liquidity suggests that Chinasoft International's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Chinasoft International boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Chinasoft International's EBIT dived 16%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chinasoft International's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. Chinasoft International 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, Chinasoft International recorded free cash flow worth 72% 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 Chinasoft International has net cash of CN¥1.66b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥319m, being 72% of its EBIT. So is Chinasoft International's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Chinasoft International, you may well want to click here to check an interactive graph of its earnings per share history.
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.