These 4 Measures Indicate That Sprocomm Intelligence (HKG:1401) Is Using Debt Extensively

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.' 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 Sprocomm Intelligence Limited (HKG:1401) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. 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 Debt?

The image below, which you can click on for greater detail, shows that Sprocomm Intelligence had debt of CN¥81.1m at the end of June 2022, a reduction from CN¥106.8m over a year. But it also has CN¥85.4m in cash to offset that, meaning it has CN¥4.36m net cash.

How Healthy Is Sprocomm Intelligence's Balance Sheet?

The latest balance sheet data shows that Sprocomm Intelligence had liabilities of CN¥1.11b due within a year, and liabilities of CN¥46.8m falling due after that. Offsetting these obligations, it had cash of CN¥85.4m as well as receivables valued at CN¥236.8m due within 12 months. So its liabilities total CN¥831.9m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥589.8m, we think shareholders really should watch Sprocomm Intelligence's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Sprocomm Intelligence boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

We also note that Sprocomm Intelligence improved its EBIT from a last year's loss to a positive CN¥1.9m. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sprocomm Intelligence's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sprocomm Intelligence 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. During the last year, Sprocomm Intelligence burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While Sprocomm Intelligence does have more liabilities than liquid assets, it also has net cash of CN¥4.36m. However, we do find both Sprocomm Intelligence's conversion of EBIT to free cash flow and its interest cover troubling. So even though it has net cash, we do think the business has some risks worth watching. The balance sheet is clearly the area to focus on when you are analysing debt. 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 is significant!) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.