Is salesforce.com (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.' 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. Importantly, salesforce.com, inc. (NYSE:CRM) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for salesforce.com

How Much Debt Does salesforce.com Carry?

The image below, which you can click on for greater detail, shows that salesforce.com had debt of US$2.68b at the end of October 2020, a reduction from US$2.82b over a year. However, it does have US$9.49b in cash offsetting this, leading to net cash of US$6.82b.

How Healthy Is salesforce.com's Balance Sheet?

The latest balance sheet data shows that salesforce.com had liabilities of US$12.2b due within a year, and liabilities of US$6.59b falling due after that. Offsetting this, it had US$9.49b in cash and US$3.89b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.44b.

Of course, salesforce.com has a titanic market capitalization of US$218.7b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, salesforce.com boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact salesforce.com's saving grace is its low debt levels, because its EBIT has tanked 60% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 salesforce.com's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While salesforce.com 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, salesforce.com actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

We could understand if investors are concerned about salesforce.com's liabilities, but we can be reassured by the fact it has has net cash of US$6.82b. And it impressed us with free cash flow of US$3.6b, being 618% of its EBIT. So we are not troubled with salesforce.com's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with salesforce.com (including 1 which can't be ignored) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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