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Is Alarm.com Holdings (NASDAQ:ALRM) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Alarm.com Holdings, Inc. (NASDAQ:ALRM) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Alarm.com Holdings

How Much Debt Does Alarm.com Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Alarm.com Holdings had US$488.8m of debt, an increase on US$416.9m, over one year. However, it does have US$643.4m in cash offsetting this, leading to net cash of US$154.6m.

debt-equity-history-analysis
debt-equity-history-analysis

How Strong Is Alarm.com Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Alarm.com Holdings had liabilities of US$141.4m due within 12 months and liabilities of US$536.7m due beyond that. Offsetting these obligations, it had cash of US$643.4m as well as receivables valued at US$108.3m due within 12 months. So it actually has US$73.5m more liquid assets than total liabilities.

This surplus suggests that Alarm.com Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Alarm.com Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Alarm.com Holdings's saving grace is its low debt levels, because its EBIT has tanked 23% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Alarm.com Holdings'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Alarm.com Holdings 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 last three years, Alarm.com Holdings recorded free cash flow worth a fulsome 80% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Alarm.com Holdings has US$154.6m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$36m, being 80% of its EBIT. So we don't have any problem with Alarm.com Holdings's use of debt. 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. We've identified 2 warning signs with Alarm.com Holdings , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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