Sinosoft Technology Group (HKG:1297) Has A Pretty Healthy Balance Sheet

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.' 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 can see that Sinosoft Technology Group Limited (HKG:1297) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sinosoft Technology Group

What Is Sinosoft Technology Group's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Sinosoft Technology Group had debt of CN¥79.8m, up from CN¥10.0m in one year. However, it does have CN¥699.1m in cash offsetting this, leading to net cash of CN¥619.3m.

How Healthy Is Sinosoft Technology Group's Balance Sheet?

We can see from the most recent balance sheet that Sinosoft Technology Group had liabilities of CN¥340.6m falling due within a year, and liabilities of CN¥87.7m due beyond that. On the other hand, it had cash of CN¥699.1m and CN¥1.34b worth of receivables due within a year. So it can boast CN¥1.61b more liquid assets than total liabilities.

This excess liquidity is a great indication that Sinosoft Technology Group's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Sinosoft Technology Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Sinosoft Technology Group's saving grace is its low debt levels, because its EBIT has tanked 55% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 6.6% 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, you should keep in mind that Sinosoft Technology Group has net cash of CN¥619.3m, as well as more liquid assets than liabilities. So we don't have any problem with Sinosoft Technology Group's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Sinosoft Technology Group (1 shouldn't be ignored) 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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