Health Check: How Prudently Does Megasoft (NSE:MEGASOFT) Use Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Megasoft Limited (NSE:MEGASOFT) does carry debt. But the real question is whether this debt is making the company risky.

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Megasoft

What Is Megasoft's Net Debt?

As you can see below, Megasoft had ₹250.0m of debt at March 2022, down from ₹295.0m a year prior. But it also has ₹372.4m in cash to offset that, meaning it has ₹122.4m net cash.

How Healthy Is Megasoft's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Megasoft had liabilities of ₹536.8m due within 12 months and liabilities of ₹479.6m due beyond that. On the other hand, it had cash of ₹372.4m and ₹302.1m worth of receivables due within a year. So its liabilities total ₹342.1m more than the combination of its cash and short-term receivables.

Of course, Megasoft has a market capitalization of ₹3.29b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Megasoft also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is Megasoft's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Megasoft had a loss before interest and tax, and actually shrunk its revenue by 12%, to ₹524m. We would much prefer see growth.

So How Risky Is Megasoft?

Although Megasoft had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of ₹46m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. We've identified 4 warning signs with Megasoft (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.