Is Salesforce (NYSE:CRM) Using Too Much Debt?

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.' 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 Salesforce, Inc. (NYSE:CRM) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

Check out our latest analysis for Salesforce

What Is Salesforce's Net Debt?

As you can see below, Salesforce had US$9.43b of debt, at April 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has US$17.7b in cash to offset that, meaning it has US$8.24b net cash.

How Strong Is Salesforce's Balance Sheet?

The latest balance sheet data shows that Salesforce had liabilities of US$23.1b due within a year, and liabilities of US$13.3b falling due after that. Offsetting this, it had US$17.7b in cash and US$4.27b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$14.6b.

Since publicly traded Salesforce shares are worth a very impressive total of US$254.8b, 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, Salesforce also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Salesforce grew its EBIT by 123% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Salesforce'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Salesforce 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, Salesforce 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

We could understand if investors are concerned about Salesforce's liabilities, but we can be reassured by the fact it has has net cash of US$8.24b. The cherry on top was that in converted 246% of that EBIT to free cash flow, bringing in US$11b. So we don't think Salesforce's use of debt is risky. 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. For instance, we've identified 1 warning sign for Salesforce that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.