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 Pure Storage, Inc. (NYSE:PSTG) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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.

What Is Pure Storage's Debt?

The image below, which you can click on for greater detail, shows that Pure Storage had debt of US$100.0m at the end of February 2024, a reduction from US$574.5m over a year. However, its balance sheet shows it holds US$1.53b in cash, so it actually has US$1.43b net cash.

How Strong Is Pure Storage's Balance Sheet?

We can see from the most recent balance sheet that Pure Storage had liabilities of US$1.37b falling due within a year, and liabilities of US$1.02b due beyond that. On the other hand, it had cash of US$1.53b and US$662.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$192.4m.

This state of affairs indicates that Pure Storage's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$17.2b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Pure Storage also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Pure Storage has increased its EBIT by 4.9% over twelve months, which should ease any concerns about debt repayment. 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 Pure Storage can strengthen its balance sheet over time. 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. Pure Storage 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, Pure Storage actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

We could understand if investors are concerned about Pure Storage's liabilities, but we can be reassured by the fact it has has net cash of US$1.43b. The cherry on top was that in converted 641% of that EBIT to free cash flow, bringing in US$483m. So is Pure Storage's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Pure Storage has 3 warning signs we think 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.

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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.