Here's Why Megasoft (NSE:MEGASOFT) Can Afford Some Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Megasoft Limited (NSE:MEGASOFT) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Megasoft

How Much Debt Does Megasoft Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Megasoft had ₹1.49b of debt, an increase on none, over one year. On the flip side, it has ₹263.1m in cash leading to net debt of about ₹1.23b.

How Strong Is Megasoft's Balance Sheet?

According to the last reported balance sheet, Megasoft had liabilities of ₹237.9m due within 12 months, and liabilities of ₹1.63b due beyond 12 months. Offsetting these obligations, it had cash of ₹263.1m as well as receivables valued at ₹500.0m due within 12 months. So it has liabilities totalling ₹1.10b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of ₹1.54b, so it does suggest shareholders should keep an eye on Megasoft's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Megasoft 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.

Over 12 months, Megasoft made a loss at the EBIT level, and saw its revenue drop to ₹156m, which is a fall of 71%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Megasoft's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable ₹299m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of ₹163m and the profit of ₹78m. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. 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. We've identified 5 warning signs with Megasoft (at least 1 which is significant) , and understanding them should be part of your investment process.

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.

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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.