Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Sprouts Farmers Market, Inc. (NASDAQ:SFM) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Sprouts Farmers Market's Net Debt?

As you can see below, Sprouts Farmers Market had US$125.0m of debt at March 2024, down from US$225.0m a year prior. However, it does have US$312.3m in cash offsetting this, leading to net cash of US$187.3m.

How Healthy Is Sprouts Farmers Market's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sprouts Farmers Market had liabilities of US$585.9m due within 12 months and liabilities of US$1.68b due beyond that. Offsetting these obligations, it had cash of US$312.3m as well as receivables valued at US$36.3m due within 12 months. So it has liabilities totalling US$1.91b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Sprouts Farmers Market is worth US$7.61b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Sprouts Farmers Market also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Sprouts Farmers Market has increased its EBIT by 7.3% over twelve months, which should ease any concerns about debt repayment. 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 Sprouts Farmers Market's ability to maintain a healthy balance sheet going forward. 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. Sprouts Farmers Market 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. During the last three years, Sprouts Farmers Market produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although Sprouts Farmers Market's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$187.3m. And it impressed us with free cash flow of US$275m, being 73% of its EBIT. So we don't think Sprouts Farmers Market's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Sprouts Farmers Market that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.