We Think Paycom Software (NYSE:PAYC) Can Manage Its Debt With Ease

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Paycom Software, Inc. (NYSE:PAYC) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Paycom Software

What Is Paycom Software's Net Debt?

The chart below, which you can click on for greater detail, shows that Paycom Software had US$29.0m in debt in March 2023; about the same as the year before. However, its balance sheet shows it holds US$505.6m in cash, so it actually has US$476.6m net cash.

A Look At Paycom Software's Liabilities

The latest balance sheet data shows that Paycom Software had liabilities of US$2.57b due within a year, and liabilities of US$342.1m falling due after that. Offsetting these obligations, it had cash of US$505.6m as well as receivables valued at US$17.8m due within 12 months. So its liabilities total US$2.38b more than the combination of its cash and short-term receivables.

Of course, Paycom Software has a titanic market capitalization of US$18.5b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Paycom Software boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Paycom Software has boosted its EBIT by 45%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Paycom Software's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Paycom Software 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 most recent three years, Paycom Software recorded free cash flow worth 68% 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

Although Paycom Software'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$476.6m. And we liked the look of last year's 45% year-on-year EBIT growth. So we don't think Paycom Software'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 Paycom Software's earnings per share history for free.

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.