These 4 Measures Indicate That Alibaba Group Holding (NYSE:BABA) Is Using Debt Safely

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Alibaba Group Holding Limited (NYSE:BABA) makes use of debt. But the real question is whether this debt is making the company risky.

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Alibaba Group Holding

What Is Alibaba Group Holding's Net Debt?

As you can see below, at the end of December 2022, Alibaba Group Holding had CN¥159.8b of debt, up from CN¥139.6b a year ago. Click the image for more detail. But on the other hand it also has CN¥519.2b in cash, leading to a CN¥359.4b net cash position.

A Look At Alibaba Group Holding's Liabilities

The latest balance sheet data shows that Alibaba Group Holding had liabilities of CN¥417.8b due within a year, and liabilities of CN¥254.2b falling due after that. On the other hand, it had cash of CN¥519.2b and CN¥71.2b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥81.6b.

Since publicly traded Alibaba Group Holding shares are worth a very impressive total of CN¥1.59t, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Alibaba Group Holding also has more cash than debt, so we're pretty confident it can manage its debt safely.

If Alibaba Group Holding can keep growing EBIT at last year's rate of 18% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Alibaba Group 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Alibaba Group 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, Alibaba Group Holding 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

We could understand if investors are concerned about Alibaba Group Holding's liabilities, but we can be reassured by the fact it has has net cash of CN¥359.4b. The cherry on top was that in converted 137% of that EBIT to free cash flow, bringing in CN¥108b. So is Alibaba Group 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Alibaba Group Holding is showing 2 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.