Here's Why Alarm.com Holdings (NASDAQ:ALRM) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Alarm.com Holdings, Inc. (NASDAQ:ALRM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Alarm.com Holdings

What Is Alarm.com Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2019 Alarm.com Holdings had US$64.0m of debt, an increase on US$68.0, over one year. But it also has US$164.3m in cash to offset that, meaning it has US$100.3m net cash.

How Healthy Is Alarm.com Holdings's Balance Sheet?

According to the last reported balance sheet, Alarm.com Holdings had liabilities of US$56.7m due within 12 months, and liabilities of US$108.1m due beyond 12 months. Offsetting this, it had US$164.3m in cash and US$65.9m in receivables that were due within 12 months. So it can boast US$65.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Alarm.com Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Alarm.com Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Alarm.com Holdings saw its EBIT decline by 3.3% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Alarm.com Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Alarm.com Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Alarm.com Holdings recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Alarm.com Holdings has US$100.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$35m, being 71% of its EBIT. So is Alarm.com Holdings'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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Alarm.com Holdings you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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