Is Neusoft (SHSE:600718) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Neusoft Corporation (SHSE:600718) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Neusoft

What Is Neusoft's Debt?

As you can see below, Neusoft had CN¥1.07b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥2.44b in cash, so it actually has CN¥1.37b net cash.

How Strong Is Neusoft's Balance Sheet?

The latest balance sheet data shows that Neusoft had liabilities of CN¥7.67b due within a year, and liabilities of CN¥1.92b falling due after that. Offsetting these obligations, it had cash of CN¥2.44b as well as receivables valued at CN¥2.48b due within 12 months. So its liabilities total CN¥4.67b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Neusoft has a market capitalization of CN¥15.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Neusoft boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Neusoft turned things around in the last 12 months, delivering and EBIT of CN¥318m. 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 Neusoft'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. While Neusoft 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. Over the last year, Neusoft actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While Neusoft does have more liabilities than liquid assets, it also has net cash of CN¥1.37b. And it impressed us with free cash flow of CN¥588m, being 185% of its EBIT. So we don't have any problem with Neusoft's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Neusoft has 3 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.