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 “. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that ServiceNow, Inc. (NYSE:NOW) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
Why is debt risky?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, many companies use debt to finance their growth, without any negative consequences. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
See our latest analysis for ServiceNow
What is ServiceNow’s debt?
As you can see below, ServiceNow had $1.57 billion in debt, as of March 2022, which is about the same as the year before. You can click on the graph for more details. But he also has $4.01 billion in cash to offset that, which means he has $2.44 billion in net cash.
A Look at ServiceNow Responsibilities
We can see from the most recent balance sheet that ServiceNow had liabilities of US$4.85 billion due in one year, and liabilities of US$2.14 billion due beyond. In return, it had $4.01 billion in cash and $824.0 million in receivables due within 12 months. Thus, its liabilities total $2.16 billion more than the combination of its cash and short-term receivables.
Of course, ServiceNow has a titanic market capitalization of US$97.1 billion, so those liabilities are probably manageable. That said, it is clear that we must continue to monitor its record, lest it deteriorate. While it has liabilities worth noting, ServiceNow also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Although ServiceNow doesn’t appear to have gained much on the EBIT line, at least earnings are holding steady for now. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether ServiceNow 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. ServiceNow may have net cash on the balance sheet, but it’s always interesting to look at how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its capacity. to manage debt. Fortunately for all shareholders, ServiceNow has actually produced more free cash flow than EBIT for the past three years. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summary
We could understand if investors are worried about ServiceNow’s liabilities, but we can take comfort in the fact that it has a net cash position of $2.44 billion. And it impressed us with free cash flow of $1.9 billion, or 749% of its EBIT. So is ServiceNow’s debt a risk? This does not seem to us to be the case. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. To this end, you should be aware of the 1 warning sign we spotted with ServiceNow.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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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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