Paycom Software (NYSE:PAYC) Seems To Use Debt Rather Sparingly

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 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 note that Paycom Software, Inc. (NYSE:PAYC) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Paycom Software

What Is Paycom Software's Debt?

You can click the graphic below for the historical numbers, but it shows that Paycom Software had US$28.7m of debt in March 2022, down from US$30.5m, one year before. But on the other hand it also has US$360.6m in cash, leading to a US$331.9m net cash position.

How Healthy Is Paycom Software's Balance Sheet?

The latest balance sheet data shows that Paycom Software had liabilities of US$4.11b due within a year, and liabilities of US$323.0m falling due after that. Offsetting this, it had US$360.6m in cash and US$17.9m in receivables that were due within 12 months. So its liabilities total US$4.06b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Paycom Software is worth a massive US$17.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Paycom Software 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 Paycom Software has boosted its EBIT by 49%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Paycom Software's ability to maintain a healthy balance sheet going forward. 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. Paycom Software 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. Over the most recent three years, Paycom Software recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although Paycom Software's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$331.9m. And we liked the look of last year's 49% year-on-year EBIT growth. So we don't think Paycom Software's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Paycom Software , and understanding them should be part of your investment process.

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.