Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Sonata Software Limited (NSE:SONATSOFTW) uses debt. But does this debt worry shareholders?
Why is debt risky?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
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What is Sonata Software’s debt?
As you can see below, Sonata Software had a debt of ₹1.59 billion in March 2022, up from ₹1.85 billion in the previous year. But he also has ₹8.96 billion in cash to offset this, meaning he has a net cash of ₹7.36 billion.
How strong is Sonata Software’s balance sheet?
The latest balance sheet data shows that Sonata Software had liabilities of ₹12.9 billion due within one year, and liabilities of ₹1.66 billion falling due thereafter. In return, he had ₹8.96 billion in cash and ₹9.81 billion in receivables due within 12 months. So he actually has ₹4.21 billion After liquid assets than total liabilities.
This surplus suggests that Sonata Software has a conservative balance sheet, and could probably eliminate its debt without too much difficulty. In summary, Sonata Software has a net cash position, so it’s fair to say that it doesn’t have a lot of debt!
On top of that, Sonata Software has grown its EBIT by 31% over the last twelve months, and this growth will make it easier to manage its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Sonata Software can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a company can only repay its debts with cold hard cash, not with book profits. Sonata Software may have net cash on the balance sheet, but it is always interesting to see how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its needs and its capacity. . to manage debt. Fortunately for all shareholders, Sonata Software has actually produced more free cash flow than EBIT for the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it’s always a good idea to investigate a company’s debt, in this case Sonata Software has ₹7.36 billion in net cash and a decent balance sheet. And it impressed us with a free cash flow of ₹4.4 billion, or 110% of its EBIT. So is Sonata Software’s debt a risk? This does not seem to us to be the case. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example – Sonata Software has 2 warning signs we think you should know.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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