Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Sinosoft Technology Group Limited (HKG:1297) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Sinosoft Technology Group Carry?
As you can see below, at the end of December 2018, Sinosoft Technology Group had CN¥50.0m of debt, up from none a year ago. Click the image for more detail. However, it does have CN¥196.2m in cash offsetting this, leading to net cash of CN¥146.2m.
How Healthy Is Sinosoft Technology Group's Balance Sheet?
We can see from the most recent balance sheet that Sinosoft Technology Group had liabilities of CN¥261.2m falling due within a year, and liabilities of CN¥51.1m due beyond that. Offsetting this, it had CN¥196.2m in cash and CN¥1.01b in receivables that were due within 12 months. So it can boast CN¥890.6m more liquid assets than total liabilities.
This surplus liquidity suggests that Sinosoft Technology Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Succinctly put, Sinosoft Technology Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, Sinosoft Technology Group grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sinosoft Technology Group'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sinosoft Technology Group 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 last three years, Sinosoft Technology Group reported free cash flow worth 11% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
While we empathize with investors who find debt concerning, you should keep in mind that Sinosoft Technology Group has net cash of CN¥146m, as well as more liquid assets than liabilities. And we liked the look of last year's 27% year-on-year EBIT growth. So we don't think Sinosoft Technology Group's use of debt is risky. We'd be very excited to see if Sinosoft Technology Group insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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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