Chinasoft International (HKG:354) Seems To Use Debt Quite Sensibly

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Chinasoft International Limited (HKG:354) does carry 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. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for Chinasoft International

What Is Chinasoft International's Debt?

As you can see below, at the end of December 2023, Chinasoft International had CN¥3.02b of debt, up from CN¥1.93b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥4.44b in cash, so it actually has CN¥1.43b net cash.

How Strong Is Chinasoft International's Balance Sheet?

The latest balance sheet data shows that Chinasoft International had liabilities of CN¥2.96b due within a year, and liabilities of CN¥2.34b falling due after that. Offsetting these obligations, it had cash of CN¥4.44b as well as receivables valued at CN¥8.37b due within 12 months. So it can boast CN¥7.51b more liquid assets than total liabilities.

This surplus strongly suggests that Chinasoft International has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Chinasoft International boasts net cash, so it's fair to say it does not have a heavy debt load!

The bad news is that Chinasoft International saw its EBIT decline by 19% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Chinasoft International 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Chinasoft International has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Chinasoft International generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Chinasoft International has CN¥1.43b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in CN¥492m. So is Chinasoft International's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Chinasoft International, you may well want to click here to check an interactive graph of its earnings per share history.

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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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.