BAE Systems (LON:BA.) Seems To Use Debt Quite Sensibly

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 note that BAE Systems plc (LON:BA.) does have debt on its balance sheet. But is this debt a concern to shareholders?

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When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does BAE Systems Carry?

The image below, which you can click on for greater detail, shows that BAE Systems had debt of UK£7.69b at the end of June 2025, a reduction from UK£8.97b over a year. However, it does have UK£2.15b in cash offsetting this, leading to net debt of about UK£5.54b.

How Healthy Is BAE Systems' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that BAE Systems had liabilities of UK£11.6b due within 12 months and liabilities of UK£13.4b due beyond that. Offsetting this, it had UK£2.15b in cash and UK£7.34b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£15.5b.

BAE Systems has a very large market capitalization of UK£52.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

Check out our latest analysis for BAE Systems

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

BAE Systems has net debt worth 1.7 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.4 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. We saw BAE Systems grow its EBIT by 4.5% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if BAE Systems 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, BAE Systems generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, BAE Systems's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And we also thought its net debt to EBITDA was a positive. All these things considered, it appears that BAE Systems can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. For example - BAE Systems has 1 warning sign we think you should be aware of.

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.