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

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Linewell Software Co., Ltd. (SHSE:603636) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Linewell Software

What Is Linewell Software's Net Debt?

As you can see below, at the end of September 2024, Linewell Software had CN¥1.70b of debt, up from CN¥1.40b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥312.5m, its net debt is less, at about CN¥1.39b.

How Healthy Is Linewell Software's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Linewell Software had liabilities of CN¥3.03b due within 12 months and liabilities of CN¥468.8m due beyond that. 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¥6.83b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Linewell Software can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Linewell Software had a loss before interest and tax, and actually shrunk its revenue by 27%, to CN¥1.3b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Linewell Software's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥72m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥183m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Linewell Software .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.