Does Sonata Software (NSE:SONATSOFTW) Have A Healthy Balance Sheet?

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 Sonata Software Limited (NSE:SONATSOFTW) does use debt in its business. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Sonata Software

What Is Sonata Software's Debt?

The image below, which you can click on for greater detail, shows that at September 2022 Sonata Software had debt of ₹1.01b, up from ₹659.8m in one year. However, its balance sheet shows it holds ₹6.36b in cash, so it actually has ₹5.34b net cash.

How Strong Is Sonata Software's Balance Sheet?

The latest balance sheet data shows that Sonata Software had liabilities of ₹15.6b due within a year, and liabilities of ₹1.29b falling due after that. Offsetting this, it had ₹6.36b in cash and ₹13.2b in receivables that were due within 12 months. So it can boast ₹2.70b more liquid assets than total liabilities.

This surplus suggests that Sonata Software has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Sonata Software has more cash than debt is arguably a good indication that it can manage its debt safely.

Also positive, Sonata Software grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. 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 Sonata Software'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sonata Software 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 three years, Sonata Software produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sonata Software has net cash of ₹5.34b, as well as more liquid assets than liabilities. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in ₹425m. So we don't think Sonata Software's use of debt is risky. 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. Be aware that Sonata Software is showing 3 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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.