These 4 Measures Indicate That Alarm.com Holdings (NASDAQ:ALRM) Is Using Debt Safely

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Alarm.com Holdings, Inc. (NASDAQ:ALRM) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

View our latest analysis for Alarm.com Holdings

What Is Alarm.com Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Alarm.com Holdings had US$491.9m in debt in June 2023; about the same as the year before. But it also has US$627.0m in cash to offset that, meaning it has US$135.1m net cash.

How Strong Is Alarm.com Holdings' Balance Sheet?

The latest balance sheet data shows that Alarm.com Holdings had liabilities of US$165.9m due within a year, and liabilities of US$544.7m falling due after that. Offsetting this, it had US$627.0m in cash and US$123.3m in receivables that were due within 12 months. So it actually has US$39.7m more liquid assets than total liabilities.

Having regard to Alarm.com Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$3.05b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Alarm.com Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Alarm.com Holdings has increased its EBIT by 7.6% over twelve months, which should ease any concerns about debt repayment. 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 Alarm.com Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Alarm.com Holdings 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 last three years, Alarm.com Holdings recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Alarm.com Holdings has net cash of US$135.1m, as well as more liquid assets than liabilities. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in US$66m. So we don't think Alarm.com Holdings's use of debt is risky. 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. Case in point: We've spotted 2 warning signs for Alarm.com Holdings you should be aware of, and 1 of them is concerning.

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.