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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Shopify Inc. (NYSE:SHOP) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Shopify Carry?
The chart below, which you can click on for greater detail, shows that Shopify had US$911.5m in debt in March 2022; about the same as the year before. But on the other hand it also has US$7.25b in cash, leading to a US$6.34b net cash position.
How Strong Is Shopify's Balance Sheet?
We can see from the most recent balance sheet that Shopify had liabilities of US$681.9m falling due within a year, and liabilities of US$1.36b due beyond that. On the other hand, it had cash of US$7.25b and US$324.5m worth of receivables due within a year. So it can boast US$5.53b more liquid assets than total liabilities.
This short term liquidity is a sign that Shopify could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shopify has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that Shopify's load is not too heavy, because its EBIT was down 70% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Shopify'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shopify 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 two years, Shopify actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company's debt, in this case Shopify has US$6.34b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 216% of that EBIT to free cash flow, bringing in US$254m. So we don't have any problem with Shopify'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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Shopify you should know about.
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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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.