Is Softec (BIT:YSFT) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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, Softec S.p.A. (BIT:YSFT) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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What Is Softec's Net Debt?

As you can see below, Softec had €1.66m of debt at June 2022, down from €1.77m a year prior. On the flip side, it has €153.0k in cash leading to net debt of about €1.51m.

How Healthy Is Softec's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Softec had liabilities of €3.85m due within 12 months and liabilities of €3.12m due beyond that. Offsetting these obligations, it had cash of €153.0k as well as receivables valued at €1.81m due within 12 months. So its liabilities total €5.00m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's €4.42m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Softec'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.

In the last year Softec had a loss before interest and tax, and actually shrunk its revenue by 2.4%, to €5.2m. We would much prefer see growth.

Caveat Emptor

Importantly, Softec had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable €836k at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through €423k in negative free cash flow over the last year. That means it's on the risky side of things. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 4 warning signs we've spotted with Softec .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.