Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Alarm.com Holdings, Inc. (NASDAQ:ALRM) 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Alarm.com Holdings

How Much Debt Does Alarm.com Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2022 Alarm.com Holdings had debt of US$488.8m, up from US$416.9m in one year. However, it does have US$643.4m in cash offsetting this, leading to net cash of US$154.6m.

How Strong Is Alarm.com Holdings' Balance Sheet?

According to the last reported balance sheet, Alarm.com Holdings had liabilities of US$141.4m due within 12 months, and liabilities of US$536.7m due beyond 12 months. Offsetting these obligations, it had cash of US$643.4m as well as receivables valued at US$108.3m due within 12 months. So it actually has US$73.5m more liquid assets than total liabilities.

This surplus suggests that Alarm.com Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Alarm.com Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Alarm.com Holdings if management cannot prevent a repeat of the 23% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Alarm.com Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Alarm.com Holdings 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, Alarm.com Holdings generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Alarm.com Holdings has net cash of US$154.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$36m, being 80% of its EBIT. So we don't have any problem with Alarm.com Holdings's use of debt. 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. For example - Alarm.com Holdings has 2 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.