Here's Why Sinosoft Technology Group (HKG:1297) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Sinosoft Technology Group Limited (HKG:1297) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Sinosoft Technology Group's Net Debt?

As you can see below, Sinosoft Technology Group had CN¥20.0m of debt at December 2021, down from CN¥80.0m a year prior. However, its balance sheet shows it holds CN¥208.0m in cash, so it actually has CN¥188.0m net cash.

A Look At Sinosoft Technology Group's Liabilities

We can see from the most recent balance sheet that Sinosoft Technology Group had liabilities of CN¥213.8m falling due within a year, and liabilities of CN¥77.2m due beyond that. On the other hand, it had cash of CN¥208.0m and CN¥1.31b worth of receivables due within a year. So it actually has CN¥1.22b more liquid assets than total liabilities.

This luscious liquidity implies that Sinosoft Technology Group's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe 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 manage its debt safely.

The modesty of its debt load may become crucial for Sinosoft Technology Group if management cannot prevent a repeat of the 96% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sinosoft Technology Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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 18% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While we empathize with investors who find debt concerning, the bottom line is that Sinosoft Technology Group has net cash of CN¥188.0m and plenty of liquid assets. So we are not troubled with Sinosoft Technology Group's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Sinosoft Technology Group that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.