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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that SPS Commerce, Inc. (NASDAQ:SPSC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does SPS Commerce Carry?
As you can see below, at the end of December 2020, SPS Commerce had US$1.90m of debt, up from none a year ago. Click the image for more detail. But it also has US$187.5m in cash to offset that, meaning it has US$185.6m net cash.
How Healthy Is SPS Commerce's Balance Sheet?
According to the last reported balance sheet, SPS Commerce had liabilities of US$80.1m due within 12 months, and liabilities of US$25.6m due beyond 12 months. Offsetting this, it had US$187.5m in cash and US$33.6m in receivables that were due within 12 months. So it can boast US$115.3m more liquid assets than total liabilities.
This surplus suggests that SPS Commerce has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, SPS Commerce 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 SPS Commerce has boosted its EBIT by 30%, thus reducing the spectre of future debt repayments. 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 SPS Commerce 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. SPS Commerce 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, SPS Commerce 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 we empathize with investors who find debt concerning, you should keep in mind that SPS Commerce has net cash of US$185.6m, as well as more liquid assets than liabilities. The cherry on top was that in converted 149% of that EBIT to free cash flow, bringing in US$72m. So we don't think SPS Commerce's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for SPS Commerce you should be aware of.
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.
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. 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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