Is ServiceNow (NYSE:NOW) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that ServiceNow, Inc. (NYSE:NOW) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for ServiceNow

What Is ServiceNow's Debt?

The chart below, which you can click on for greater detail, shows that ServiceNow had US$1.49b in debt in June 2023; about the same as the year before. But on the other hand it also has US$4.75b in cash, leading to a US$3.26b net cash position.

A Look At ServiceNow's Liabilities

Zooming in on the latest balance sheet data, we can see that ServiceNow had liabilities of US$5.77b due within 12 months and liabilities of US$2.23b due beyond that. Offsetting these obligations, it had cash of US$4.75b as well as receivables valued at US$1.09b due within 12 months. So it has liabilities totalling US$2.16b more than its cash and near-term receivables, combined.

Having regard to ServiceNow's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$114.5b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, ServiceNow boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, ServiceNow grew its EBIT by 133% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ServiceNow 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, a company can only pay off debt with cold hard cash, not accounting profits. While ServiceNow 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, ServiceNow 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

While it is always sensible to look at a company's total liabilities, it is very reassuring that ServiceNow has US$3.26b in net cash. The cherry on top was that in converted 608% of that EBIT to free cash flow, bringing in US$2.3b. So we don't think ServiceNow's use of debt is risky. 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. We've identified 2 warning signs with ServiceNow (at least 1 which is concerning) , and understanding them should be part of your investment process.

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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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.