ServiceNow (NYSE:NOW) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that ServiceNow, Inc. (NYSE:NOW) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for ServiceNow

What Is ServiceNow's Net Debt?

The chart below, which you can click on for greater detail, shows that ServiceNow had US$1.49b in debt in June 2024; about the same as the year before. However, its balance sheet shows it holds US$5.41b in cash, so it actually has US$3.93b net cash.

How Healthy Is ServiceNow's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ServiceNow had liabilities of US$7.17b due within 12 months and liabilities of US$2.37b due beyond that. Offsetting these obligations, it had cash of US$5.41b as well as receivables valued at US$1.52b due within 12 months. So it has liabilities totalling US$2.61b more than its cash and near-term receivables, combined.

This state of affairs indicates that ServiceNow's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$176.0b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, ServiceNow also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, ServiceNow grew its EBIT by 112% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. ServiceNow may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, ServiceNow actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that ServiceNow has US$3.93b in net cash. And it impressed us with free cash flow of US$3.1b, being 410% of its EBIT. So we don't think ServiceNow's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with ServiceNow .

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.