Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Cloudflare, Inc. (NYSE:NET) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Cloudflare's Debt?

The image below, which you can click on for greater detail, shows that Cloudflare had debt of US$1.28b at the end of March 2024, a reduction from US$1.44b over a year. But it also has US$1.72b in cash to offset that, meaning it has US$431.9m net cash.

How Strong Is Cloudflare's Balance Sheet?

We can see from the most recent balance sheet that Cloudflare had liabilities of US$574.1m falling due within a year, and liabilities of US$1.43b due beyond that. Offsetting these obligations, it had cash of US$1.72b as well as receivables valued at US$224.8m due within 12 months. So it has liabilities totalling US$63.4m more than its cash and near-term receivables, combined.

Having regard to Cloudflare's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$28.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Cloudflare boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Cloudflare'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.

Over 12 months, Cloudflare reported revenue of US$1.4b, which is a gain of 32%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Cloudflare?

Although Cloudflare had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of US$141m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. One positive is that Cloudflare is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But we still think it's somewhat risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Cloudflare that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com