Is ServiceNow (NYSE:NOW) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, ServiceNow, Inc. (NYSE:NOW) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for ServiceNow

What Is ServiceNow's Net Debt?

As you can see below, ServiceNow had US$1.49b of debt at December 2022, down from US$1.58b a year prior. However, it does have US$4.28b in cash offsetting this, leading to net cash of US$2.79b.

How Healthy Is ServiceNow's Balance Sheet?

We can see from the most recent balance sheet that ServiceNow had liabilities of US$6.01b falling due within a year, and liabilities of US$2.26b due beyond that. Offsetting these obligations, it had cash of US$4.28b as well as receivables valued at US$1.75b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.23b.

Of course, ServiceNow has a titanic market capitalization of US$88.3b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, ServiceNow boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that ServiceNow has boosted its EBIT by 38%, thus reducing the spectre of future debt repayments. 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 ServiceNow'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.

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. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

We could understand if investors are concerned about ServiceNow's liabilities, but we can be reassured by the fact it has has net cash of US$2.79b. And it impressed us with free cash flow of US$2.2b, being 656% of its EBIT. So is ServiceNow's debt a risk? It doesn't seem so to us. 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 instance, we've identified 1 warning sign for ServiceNow that you should be aware of.

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.