Here's Why Linewell Software (SHSE:603636) Can Afford Some Debt

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.' 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. As with many other companies Linewell Software Co., Ltd. (SHSE:603636) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Linewell Software's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Linewell Software had CN¥1.70b of debt, an increase on CN¥1.40b, over one year. However, it does have CN¥312.5m in cash offsetting this, leading to net debt of about CN¥1.39b.

A Look At Linewell Software's Liabilities

According to the last reported balance sheet, Linewell Software had liabilities of CN¥3.03b due within 12 months, and liabilities of CN¥468.8m due beyond 12 months. On the other hand, it had cash of CN¥312.5m and CN¥2.31b worth of receivables due within a year. So it has liabilities totalling CN¥874.3m more than its cash and near-term receivables, combined.

Of course, Linewell Software has a market capitalization of CN¥7.64b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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 Linewell Software will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

See our latest analysis for Linewell Software

Over 12 months, Linewell Software made a loss at the EBIT level, and saw its revenue drop to CN¥1.3b, which is a fall of 27%. That makes us nervous, to say the least.

Caveat Emptor

While Linewell Software's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥72m. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥183m of cash over the last year. So suffice it to say we do consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Linewell Software has 3 warning signs (and 2 which are a bit unpleasant) we think you should know about.

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.