These 4 Measures Indicate That Saksoft (NSE:SAKSOFT) Is Using Debt Reasonably Well

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Saksoft Limited (NSE:SAKSOFT) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Saksoft

What Is Saksoft's Debt?

You can click the graphic below for the historical numbers, but it shows that Saksoft had ₹290.2m of debt in September 2020, down from ₹366.1m, one year before. However, its balance sheet shows it holds ₹874.6m in cash, so it actually has ₹584.3m net cash.

How Strong Is Saksoft's Balance Sheet?

The latest balance sheet data shows that Saksoft had liabilities of ₹570.0m due within a year, and liabilities of ₹337.9m falling due after that. Offsetting these obligations, it had cash of ₹874.6m as well as receivables valued at ₹653.4m due within 12 months. So it can boast ₹620.1m more liquid assets than total liabilities.

This surplus suggests that Saksoft is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Saksoft boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Saksoft has seen its EBIT plunge 11% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Saksoft's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Saksoft 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, Saksoft 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 Saksoft has ₹584.3m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in ₹538m. So is Saksoft's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Saksoft , 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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