Does Xero (ASX:XRO) Have A Healthy Balance Sheet?

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 Xero Limited (ASX:XRO) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Xero

What Is Xero's Net Debt?

As you can see below, Xero had NZ$1.08b of debt, at September 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 NZ$1.95b in cash, so it actually has NZ$872.5m net cash.

How Strong Is Xero's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Xero had liabilities of NZ$1.86b due within 12 months and liabilities of NZ$160.3m due beyond that. Offsetting these obligations, it had cash of NZ$1.95b as well as receivables valued at NZ$216.5m due within 12 months. So it can boast NZ$149.4m more liquid assets than total liabilities.

This state of affairs indicates that Xero's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NZ$29.5b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Xero boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Xero grew its EBIT by 160% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Xero'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 company can only pay off debt with cold hard cash, not accounting profits. Xero 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. Over the last three years, Xero actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Xero has net cash of NZ$872.5m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NZ$446m, being 119% of its EBIT. So is Xero's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Xero, you may well want to click here to check an interactive graph of its earnings per share history.

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.