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.' 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. We note that Extreme Networks, Inc. (NASDAQ:EXTR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Extreme Networks's Debt?

As you can see below, Extreme Networks had US$192.3m of debt at December 2023, down from US$258.5m a year prior. But it also has US$221.4m in cash to offset that, meaning it has US$29.1m net cash.

How Healthy Is Extreme Networks' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Extreme Networks had liabilities of US$549.0m due within 12 months and liabilities of US$485.5m due beyond that. On the other hand, it had cash of US$221.4m and US$112.0m worth of receivables due within a year. So it has liabilities totalling US$701.0m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Extreme Networks is worth US$1.38b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Extreme Networks also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Extreme Networks grew its EBIT by 71% over the last twelve months, and that growth will make it easier to handle its debt. 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 Extreme Networks 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Extreme Networks has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Extreme Networks actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Extreme Networks'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$29.1m. And it impressed us with free cash flow of US$221m, being 191% of its EBIT. So is Extreme Networks's debt a risk? It doesn't seem so to us. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Extreme Networks insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.