Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Like many other companies Sinosoft Technology Group Limited (HKG:1297) uses debt. But should shareholders worry about its use of debt?
When is debt a problem?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Sinosoft Technology Group
What is the net debt of Sinosoft Technology Group?
As you can see below, Sinosoft Technology Group had a debt of 20.0 million yen in December 2021, compared to 80.0 million yen the previous year. However, his balance sheet shows that he holds 208.0 million yen in cash, so he actually has 188.0 million yen in cash.
A look at the responsibilities of Sinosoft Technology Group
We can see from the most recent balance sheet that Sinosoft Technology Group had liabilities of 213.8 million yen due within one year, and liabilities of 77.2 million yen due beyond. . On the other hand, it had cash of 208.0 million Canadian yen and 1.31 billion domestic yen of receivables due within one year. So it actually CN¥1.22b After liquid assets than total liabilities.
This luscious liquidity means Sinosoft Technology Group’s balance sheet is as strong as a giant sequoia. From this perspective, lenders should feel as secure as the beloved of a black belt karate master. Simply put, the fact that Sinosoft Technology Group has more cash than debt is arguably a good indication that it can safely manage its debt.
Its low leverage could become crucial for Sinosoft Technology Group if management cannot prevent a repeat of the 96% reduction in EBIT over the past year. When a company sees its profit reservoir, it can sometimes find its relationship with its lenders soured. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the profits of Sinosoft Technology Group that will influence the balance sheet in the future. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. Sinosoft Technology Group may have net cash on the balance sheet, but it is always interesting to see how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its needs and its ability to manage debt. Over the past three years, Sinosoft Technology Group has recorded free cash flow of 18% of its EBIT, which is really quite low. This low level of cash conversion compromises its ability to manage and repay its debt.
While we sympathize with investors who find debt a concern, the bottom line is that Sinosoft Technology Group has net cash of 188.0 million Canadian yen and plenty of liquid assets. We are therefore not concerned about Sinosoft Technology Group’s use of debt. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 3 warning signs for Sinosoft Technology Group of which you should be aware.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.