Is Paylocity Holding (NASDAQ:PCTY) Using Too Much Debt?

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 Paylocity Holding Corporation (NASDAQ:PCTY) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Paylocity Holding

What Is Paylocity Holding's Debt?

The image below, which you can click on for greater detail, shows that at December 2024 Paylocity Holding had debt of US$325.0m, up from none in one year. But on the other hand it also has US$482.4m in cash, leading to a US$157.4m net cash position.

How Healthy Is Paylocity Holding's Balance Sheet?

According to the last reported balance sheet, Paylocity Holding had liabilities of US$3.71b due within 12 months, and liabilities of US$416.0m due beyond 12 months. On the other hand, it had cash of US$482.4m and US$43.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.60b.

This deficit isn't so bad because Paylocity Holding is worth a massive US$11.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Paylocity Holding also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also positive, Paylocity Holding grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Paylocity Holding 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Paylocity Holding 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 last three years, Paylocity Holding actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Paylocity Holding's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$157.4m. And it impressed us with free cash flow of US$315m, being 125% of its EBIT. So is Paylocity Holding's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Paylocity Holding you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.