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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Applied Materials, Inc. (NASDAQ:AMAT) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, 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 capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Applied Materials's Net Debt?

The chart below, which you can click on for greater detail, shows that Applied Materials had US$5.56b in debt in April 2024; about the same as the year before. But it also has US$7.56b in cash to offset that, meaning it has US$2.00b net cash.

A Look At Applied Materials' Liabilities

According to the last reported balance sheet, Applied Materials had liabilities of US$6.88b due within 12 months, and liabilities of US$6.87b due beyond 12 months. Offsetting these obligations, it had cash of US$7.56b as well as receivables valued at US$5.11b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.08b.

This state of affairs indicates that Applied Materials' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$194.9b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Applied Materials boasts net cash, so it's fair to say it does not have a heavy debt load!

Applied Materials's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Applied Materials 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 company can only pay off debt with cold hard cash, not accounting profits. Applied Materials 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. During the last three years, Applied Materials produced sturdy free cash flow equating to 77% 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 look at a company's total liabilities, it is very reassuring that Applied Materials has US$2.00b in net cash. The cherry on top was that in converted 77% of that EBIT to free cash flow, bringing in US$6.8b. So we don't think Applied Materials's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Applied Materials .

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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