Is Sprocomm Intelligence (HKG:1401) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Sprocomm Intelligence Limited (HKG:1401) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sprocomm Intelligence

What Is Sprocomm Intelligence's Net Debt?

As you can see below, Sprocomm Intelligence had CN¥51.8m of debt at December 2022, down from CN¥58.2m a year prior. However, because it has a cash reserve of CN¥36.6m, its net debt is less, at about CN¥15.2m.

A Look At Sprocomm Intelligence's Liabilities

According to the last reported balance sheet, Sprocomm Intelligence had liabilities of CN¥1.10b due within 12 months, and liabilities of CN¥40.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥36.6m as well as receivables valued at CN¥259.7m due within 12 months. So its liabilities total CN¥844.0m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥441.4m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Sprocomm Intelligence would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sprocomm Intelligence will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Sprocomm Intelligence had a loss before interest and tax, and actually shrunk its revenue by 27%, to CN¥1.5b. That makes us nervous, to say the least.

Caveat Emptor

While Sprocomm Intelligence's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥24m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of CN¥547m and the profit of CN¥6.5m. So one might argue that there's still a chance it can get things on the right track. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Sprocomm Intelligence (1 doesn't sit too well with us!) that you should be aware of before investing here.

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.