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.’ 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. Importantly, Tyler Technologies, Inc. (NYSE:TYL) does carry debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 Tyler Technologies Carry?

As you can see below, at the end of March 2021, Tyler Technologies had US$591.5m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds US$1.31b in cash, so it actually has US$718.3m net cash.

A Look At Tyler Technologies’ Liabilities

Zooming in on the latest balance sheet data, we can see that Tyler Technologies had liabilities of US$525.4m due within 12 months and liabilities of US$645.4m due beyond that. On the other hand, it had cash of US$1.31b and US$347.9m worth of receivables due within a year. So it actually has US$486.9m more liquid assets than total liabilities.

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

Also good is that Tyler Technologies grew its EBIT at 14% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Tyler Technologies’s ability to maintain a healthy balance sheet going forward.

Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. Tyler Technologies 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, Tyler Technologies actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company’s debt, in this case Tyler Technologies has US$718.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$342m, being 163% of its EBIT. So we don’t think Tyler Technologies’s use of debt is risky. There’s no doubt that we learn most about debt from the balance sheet.