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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Cornerstone OnDemand, Inc. (NASDAQ:CSOD) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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, 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.
How Much Debt Does Cornerstone OnDemand Carry?
The image below, which you can click on for greater detail, shows that Cornerstone OnDemand had debt of US$291.0m at the end of June 2019, a reduction from US$540.0m over a year. However, its balance sheet shows it holds US$403.1m in cash, so it actually has US$112.1m net cash.
How Strong Is Cornerstone OnDemand's Balance Sheet?
We can see from the most recent balance sheet that Cornerstone OnDemand had liabilities of US$376.7m falling due within a year, and liabilities of US$376.6m due beyond that. Offsetting these obligations, it had cash of US$403.1m as well as receivables valued at US$103.6m due within 12 months. So its liabilities total US$246.6m more than the combination of its cash and short-term receivables.
Since publicly traded Cornerstone OnDemand shares are worth a total of US$3.22b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Cornerstone OnDemand also has more cash than debt, so we're pretty confident it can manage its debt safely.
Notably, Cornerstone OnDemand made a loss at the EBIT level, last year, but improved that to positive EBIT of US$3.1m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Cornerstone OnDemand 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. Cornerstone OnDemand 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 year, Cornerstone OnDemand actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
We could understand if investors are concerned about Cornerstone OnDemand's liabilities, but we can be reassured by the fact it has has net cash of US$112.1m. And it impressed us with free cash flow of US$62m, being 1987% of its EBIT. So we don't have any problem with Cornerstone OnDemand's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Cornerstone OnDemand insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.