The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Cloudflare, Inc. (NYSE:NET) does carry debt. 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. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Net Debt?

As you can see below, Cloudflare had US$1.29b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$1.76b in cash, so it actually has US$472.1m net cash.

A Look At Cloudflare's Liabilities

According to the last reported balance sheet, Cloudflare had liabilities of US$596.0m due within 12 months, and liabilities of US$1.44b due beyond 12 months. On the other hand, it had cash of US$1.76b and US$263.1m worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

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$31.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Cloudflare also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Cloudflare 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.

Over 12 months, Cloudflare reported revenue of US$1.5b, which is a gain of 31%, 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$159m. 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. The good news for Cloudflare shareholders is that its revenue growth is strong, making it easier to raise capital if need be. But that doesn't change our opinion that the stock is 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. Be aware that Cloudflare is showing 2 warning signs in our investment analysis , 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.