Is Sinosoft Technology Group (HKG:1297) Using Too Much Debt?

Warren Buffett famously said, '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. We note that Sinosoft Technology Group Limited (HKG:1297) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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.

Check out our latest analysis for Sinosoft Technology Group

How Much Debt Does Sinosoft Technology Group Carry?

As you can see below, at the end of June 2020, Sinosoft Technology Group had CN¥74.0m of debt, up from CN¥20.0m a year ago. Click the image for more detail. However, it does have CN¥164.7m in cash offsetting this, leading to net cash of CN¥90.7m.

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¥233.5m falling due within a year, and liabilities of CN¥78.3m due beyond that. Offsetting this, it had CN¥164.7m in cash and CN¥1.33b in receivables that were due within 12 months. So it can boast CN¥1.18b more liquid assets than total liabilities.

This surplus liquidity suggests that Sinosoft Technology Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. 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.

But the other side of the story is that Sinosoft Technology Group saw its EBIT decline by 9.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sinosoft Technology Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Sinosoft Technology Group has net cash of CN¥90.7m, as well as more liquid assets than liabilities. So we are not troubled with Sinosoft Technology Group's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Sinosoft Technology Group insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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