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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that China National Software & Service Company Limited (SHSE:600536) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for China National Software & Service
What Is China National Software & Service's Debt?
The chart below, which you can click on for greater detail, shows that China National Software & Service had CN¥1.98b in debt in June 2023; about the same as the year before. However, it does have CN¥1.59b in cash offsetting this, leading to net debt of about CN¥383.5m.
A Look At China National Software & Service's Liabilities
We can see from the most recent balance sheet that China National Software & Service had liabilities of CN¥6.12b falling due within a year, and liabilities of CN¥810.0m due beyond that. Offsetting these obligations, it had cash of CN¥1.59b as well as receivables valued at CN¥3.55b due within 12 months. So its liabilities total CN¥1.79b more than the combination of its cash and short-term receivables.
Since publicly traded China National Software & Service shares are worth a total of CN¥33.5b, 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. Carrying virtually no net debt, China National Software & Service has a very light debt load indeed. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China National Software & Service's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year China National Software & Service had a loss before interest and tax, and actually shrunk its revenue by 24%, to CN¥8.6b. To be frank that doesn't bode well.
Caveat Emptor
While China National Software & Service's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥81m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of CN¥185m. So we do think this stock is quite risky. 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. For example, we've discovered 1 warning sign for China National Software & Service that you should be aware of before investing here.
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.