Is Cloudflare (NYSE:NET) Using Debt In A Risky Way?

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. As with many other companies Cloudflare, Inc. (NYSE:NET) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Cloudflare

What Is Cloudflare's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Cloudflare had debt of US$1.44b, up from US$1.16b in one year. However, its balance sheet shows it holds US$1.65b in cash, so it actually has US$213.7m net cash.

How Strong Is Cloudflare's Balance Sheet?

We can see from the most recent balance sheet that Cloudflare had liabilities of US$397.9m falling due within a year, and liabilities of US$1.57b due beyond that. Offsetting this, it had US$1.65b in cash and US$194.3m in receivables that were due within 12 months. So it has liabilities totalling US$119.7m more than its cash and near-term receivables, combined.

Having regard to Cloudflare's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$21.4b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Cloudflare 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 ultimately the future profitability of the business will decide if Cloudflare 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.

Over 12 months, Cloudflare reported revenue of US$975m, which is a gain of 49%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

So How Risky Is Cloudflare?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Cloudflare lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through US$40m of cash and made a loss of US$193m. But the saving grace is the US$213.7m on the balance sheet. That means it could keep spending at its current rate for more than two years. Cloudflare's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. Pre-profit companies are often risky, but they can also offer great rewards. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Cloudflare (1 makes us a bit uncomfortable!) 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.