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.’ 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 iSoftStone Information Technology (Group) Co., Ltd. (SZSE:301236) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for iSoftStone Information Technology (Group)

What Is iSoftStone Information Technology (Group)’s Debt?

The image below, which you can click on for greater detail, shows that iSoftStone Information Technology (Group) had debt of CN¥1.68b at the end of September 2023, a reduction from CN¥2.74b over a year. However, it does have CN¥5.06b in cash offsetting this, leading to net cash of CN¥3.39b.

How Strong Is iSoftStone Information Technology (Group)’s Balance Sheet?

The latest balance sheet data shows that iSoftStone Information Technology (Group) had liabilities of CN¥3.71b due within a year, and liabilities of CN¥363.2m falling due after that. Offsetting these obligations, it had cash of CN¥5.06b as well as receivables valued at CN¥6.14b due within 12 months. So it can boast CN¥7.12b more liquid assets than total liabilities.

This excess liquidity suggests that iSoftStone Information Technology (Group) is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, iSoftStone Information Technology (Group) boasts net cash, so it’s fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for iSoftStone Information Technology (Group) if management cannot prevent a repeat of the 53% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine iSoftStone Information Technology (Group)’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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While iSoftStone Information Technology (Group) 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, iSoftStone Information Technology (Group) produced sturdy free cash flow equating to 53% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company’s debt, in this case iSoftStone Information Technology (Group) has CN¥3.39b in net cash and a decent-looking balance sheet. So we don’t have any problem with iSoftStone Information Technology (Group)’s use of debt. 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. Be aware that iSoftStone Information Technology (Group) is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning…

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.