Is Farfetch (NYSE:FTCH) Using Debt In A Risky Way?

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 can see that Farfetch Limited (NYSE:FTCH) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Farfetch

What Is Farfetch's Debt?

As you can see below, Farfetch had US$537.2m of debt at June 2022, down from US$612.9m a year prior. But it also has US$675.2m in cash to offset that, meaning it has US$137.9m net cash.

How Healthy Is Farfetch's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Farfetch had liabilities of US$917.7m due within 12 months and liabilities of US$1.68b due beyond that. Offsetting these obligations, it had cash of US$675.2m as well as receivables valued at US$466.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.46b.

Farfetch has a market capitalization of US$4.34b, so it could very likely raise cash to ameliorate 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, Farfetch also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Farfetch'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.

In the last year Farfetch wasn't profitable at an EBIT level, but managed to grow its revenue by 18%, to US$2.3b. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Farfetch?

While Farfetch lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of US$1.7b. So taking that on face value, and considering the cash, we don't think its very risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Farfetch (2 are significant!) that you should be aware of before investing here.

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.