Warren Buffett famously said, '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. As with many other companies Palo Alto Networks, Inc. (NASDAQ:PANW) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Palo Alto Networks Carry?

As you can see below, Palo Alto Networks had US$1.16b of debt at April 2024, down from US$3.68b a year prior. But on the other hand it also has US$2.89b in cash, leading to a US$1.73b net cash position.

How Strong Is Palo Alto Networks' Balance Sheet?

According to the last reported balance sheet, Palo Alto Networks had liabilities of US$7.08b due within 12 months, and liabilities of US$6.38b due beyond 12 months. On the other hand, it had cash of US$2.89b and US$2.29b worth of receivables due within a year. So it has liabilities totalling US$8.28b more than its cash and near-term receivables, combined.

Given Palo Alto Networks has a humongous market capitalization of US$103.7b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Palo Alto Networks boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Palo Alto Networks grew its EBIT by 489% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Palo Alto Networks'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Palo Alto Networks may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Palo Alto Networks actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Palo Alto Networks has US$1.73b in net cash. And it impressed us with free cash flow of US$3.0b, being 559% of its EBIT. So is Palo Alto Networks's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Palo Alto Networks has 3 warning signs (and 1 which can't be ignored) we think you should know about.

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.

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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.

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