Is Xero (ASX:XRO) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Xero Limited (ASX:XRO) does use debt in its business. But the more important question is: how much risk is that debt creating?

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Why Does Debt Bring Risk?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

What Is Xero's Debt?

The image below, which you can click on for greater detail, shows that at September 2025 Xero had debt of NZ$1.24b, up from NZ$1.08b in one year. However, it does have NZ$4.80b in cash offsetting this, leading to net cash of NZ$3.56b.

How Healthy Is Xero's Balance Sheet?

We can see from the most recent balance sheet that Xero had liabilities of NZ$2.21b falling due within a year, and liabilities of NZ$181.3m due beyond that. On the other hand, it had cash of NZ$4.80b and NZ$190.8m worth of receivables due within a year. So it can boast NZ$2.61b more liquid assets than total liabilities.

This surplus suggests that Xero has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Xero has more cash than debt is arguably a good indication that it can manage its debt safely.

View our latest analysis for Xero

Xero'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. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Xero can strengthen its balance sheet over time. 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. Happily for any shareholders, Xero actually produced more free cash flow than EBIT over the last three years. 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$3.56b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NZ$613m, being 142% of its EBIT. So we don't think Xero's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Xero's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.