Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Palo Alto Networks, Inc. (NYSE:PANW) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 Palo Alto Networks Carry?

You can click the graphic below for the historical numbers, but it shows that as of January 2021 Palo Alto Networks had US$3.10b of debt, an increase on US$1.46b, over one year. But it also has US$3.17b in cash to offset that, meaning it has US$74.4m net cash.

How Strong Is Palo Alto Networks’ Balance Sheet?

The latest balance sheet data shows that Palo Alto Networks had liabilities of US$4.38b due within a year, and liabilities of US$4.07b falling due after that. Offsetting these obligations, it had cash of US$3.17b as well as receivables valued at US$695.7m due within 12 months. So its liabilities total US$4.58b more than the combination of its cash and short-term receivables.

Given Palo Alto Networks has a humongous market capitalization of US$31.9b, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Palo Alto Networks boasts net cash, so it’s fair to say it does not have a heavy debt load! 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 Palo Alto Networks 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.

In the last year Palo Alto Networks wasn’t profitable at an EBIT level, but managed to grow its revenue by 21%, to US$3.8b. With any luck the company will be able to grow its way to profitability.

So How Risky Is Palo Alto Networks?

While Palo Alto Networks lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow US$1.2b. So taking that on face value, and considering the net cash situation, we don’t think that the stock is too risky in the near term. One positive is that Palo Alto Networks is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But we still think it’s somewhat risky. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we’ve identified 1 warning sign for Palo Alto Networks that you should be aware of.