We Think Chinasoft International (HKG:354) Can Manage Its Debt With Ease

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Chinasoft International Limited (HKG:354) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Chinasoft International

What Is Chinasoft International's Debt?

As you can see below, Chinasoft International had CN¥2.53b of debt at June 2021, down from CN¥3.02b a year prior. However, it does have CN¥3.80b in cash offsetting this, leading to net cash of CN¥1.27b.

A Look At Chinasoft International's Liabilities

The latest balance sheet data shows that Chinasoft International had liabilities of CN¥3.60b due within a year, and liabilities of CN¥1.34b falling due after that. On the other hand, it had cash of CN¥3.80b and CN¥7.17b worth of receivables due within a year. So it can boast CN¥6.03b more liquid assets than total liabilities.

It's good to see that Chinasoft International has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Chinasoft International boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Chinasoft International grew its EBIT at 13% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chinasoft International's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. Over the most recent three years, Chinasoft International recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Chinasoft International has net cash of CN¥1.27b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥726m, being 71% of its EBIT. So is Chinasoft International's debt a risk? It doesn't seem so to us. 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 example - Chinasoft International has 2 warning signs we think 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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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.