The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Shanghai Baosight Software Co.,Ltd. (SHSE:600845) does carry debt. But the more important question is: how much risk is that debt creating?
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. 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. 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.
How Much Debt Does Shanghai Baosight SoftwareLtd Carry?
As you can see below, Shanghai Baosight SoftwareLtd had CN¥91.1m of debt at December 2023, down from CN¥148.2m a year prior. But on the other hand it also has CN¥5.97b in cash, leading to a CN¥5.87b net cash position.
How Healthy Is Shanghai Baosight SoftwareLtd's Balance Sheet?
According to the last reported balance sheet, Shanghai Baosight SoftwareLtd had liabilities of CN¥8.89b due within 12 months, and liabilities of CN¥900.9m due beyond 12 months. On the other hand, it had cash of CN¥5.97b and CN¥7.08b worth of receivables due within a year. So it can boast CN¥3.25b more liquid assets than total liabilities.
This surplus suggests that Shanghai Baosight SoftwareLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shanghai Baosight SoftwareLtd has more cash than debt is arguably a good indication that it can manage its debt safely.
And we also note warmly that Shanghai Baosight SoftwareLtd grew its EBIT by 18% 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 Shanghai Baosight SoftwareLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Shanghai Baosight SoftwareLtd 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. Over the last three years, Shanghai Baosight SoftwareLtd recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Baosight SoftwareLtd has net cash of CN¥5.87b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.2b, being 84% of its EBIT. So is Shanghai Baosight SoftwareLtd's debt a risk? It doesn't seem so to us. 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 instance, we've identified 1 warning sign for Shanghai Baosight SoftwareLtd that you should be aware of.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.