SoftTech Engineers (NSE:SOFTTECH) Has A Pretty Healthy Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that SoftTech Engineers Limited (NSE:SOFTTECH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for SoftTech Engineers

How Much Debt Does SoftTech Engineers Carry?

The image below, which you can click on for greater detail, shows that at March 2023 SoftTech Engineers had debt of ₹480.9m, up from ₹350.2m in one year. However, it does have ₹95.5m in cash offsetting this, leading to net debt of about ₹385.4m.

How Healthy Is SoftTech Engineers' Balance Sheet?

The latest balance sheet data shows that SoftTech Engineers had liabilities of ₹427.0m due within a year, and liabilities of ₹172.1m falling due after that. Offsetting this, it had ₹95.5m in cash and ₹825.4m in receivables that were due within 12 months. So it can boast ₹321.8m more liquid assets than total liabilities.

This excess liquidity suggests that SoftTech Engineers is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Even though SoftTech Engineers's debt is only 1.8, its interest cover is really very low at 2.1. The main reason for this is that it has such high depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) Either way there's no doubt the stock is using meaningful leverage. We note that SoftTech Engineers grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is SoftTech Engineers'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, SoftTech Engineers burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

SoftTech Engineers's conversion of EBIT to free cash flow was a real negative on this analysis, as was its interest cover. But its EBIT growth rate was significantly redeeming. Considering this range of data points, we think SoftTech Engineers is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with SoftTech Engineers (including 1 which is a bit unpleasant) .

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.