Is Model N (NYSE:MODN) Using Debt Sensibly?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Model N, Inc. (NYSE:MODN) does have debt on its balance sheet. 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Model N

How Much Debt Does Model N Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Model N had debt of US$135.4m, up from US$124.3m in one year. But it also has US$193.5m in cash to offset that, meaning it has US$58.1m net cash.

How Healthy Is Model N's Balance Sheet?

We can see from the most recent balance sheet that Model N had liabilities of US$106.9m falling due within a year, and liabilities of US$150.7m due beyond that. Offsetting these obligations, it had cash of US$193.5m as well as receivables valued at US$49.1m due within 12 months. So it has liabilities totalling US$15.0m more than its cash and near-term receivables, combined.

This state of affairs indicates that Model N's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$1.58b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Model N also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Model N 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.

In the last year Model N wasn't profitable at an EBIT level, but managed to grow its revenue by 13%, to US$219m. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Model N?

While Model N lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow US$24m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. For instance, we've identified 3 warning signs for Model N that you should be aware of.

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.