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

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.' 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. We note that Chinasoft International Limited (HKG:354) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Chinasoft International

What Is Chinasoft International's Net Debt?

As you can see below, Chinasoft International had CN¥2.61b of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥4.79b in cash to offset that, meaning it has CN¥2.18b net cash.

How Strong Is Chinasoft International's Balance Sheet?

The latest balance sheet data shows that Chinasoft International had liabilities of CN¥5.20b due within a year, and liabilities of CN¥214.9m falling due after that. On the other hand, it had cash of CN¥4.79b and CN¥8.32b worth of receivables due within a year. So it actually has CN¥7.70b more liquid assets than total liabilities.

This surplus liquidity suggests that Chinasoft International's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Chinasoft International boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Chinasoft International 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 Chinasoft International can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. Over the most recent three years, Chinasoft International recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Chinasoft International has CN¥2.18b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥331m, being 72% of its EBIT. So is Chinasoft International's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Chinasoft International has 1 warning sign 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.