Does Sonata Software (NSE:SONATSOFTW) Have A 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.' 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 should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sonata Software

What Is Sonata Software's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2023 Sonata Software had debt of ₹5.91b, up from ₹1.59b in one year. However, its balance sheet shows it holds ₹9.30b in cash, so it actually has ₹3.40b net cash.

How Healthy Is Sonata Software's Balance Sheet?

According to the last reported balance sheet, Sonata Software had liabilities of ₹21.6b due within 12 months, and liabilities of ₹8.93b due beyond 12 months. Offsetting these obligations, it had cash of ₹9.30b as well as receivables valued at ₹14.0b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹7.27b.

Since publicly traded Sonata Software shares are worth a total of ₹144.8b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Sonata Software boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Sonata Software grew its EBIT by 19% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sonata Software can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sonata Software 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. During the last three years, Sonata Software produced sturdy free cash flow equating to 63% 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

We could understand if investors are concerned about Sonata Software's liabilities, but we can be reassured by the fact it has has net cash of ₹3.40b. And we liked the look of last year's 19% year-on-year EBIT growth. So we don't think Sonata Software's use of debt is risky. 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. For example, we've discovered 1 warning sign for Sonata Software that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.