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.' 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 can see that Spotify Technology S.A. (NYSE:SPOT) does use debt in its business. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.
What Is Spotify Technology's Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Spotify Technology had debt of €1.27b, up from €1.16b in one year. However, it does have €4.33b in cash offsetting this, leading to net cash of €3.06b.
How Healthy Is Spotify Technology's Balance Sheet?
We can see from the most recent balance sheet that Spotify Technology had liabilities of €3.97b falling due within a year, and liabilities of €1.80b due beyond that. Offsetting this, it had €4.33b in cash and €798.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €634.0m.
Having regard to Spotify Technology's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the €55.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Spotify Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
It was also good to see that despite losing money on the EBIT line last year, Spotify Technology turned things around in the last 12 months, delivering and EBIT of €242m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Spotify Technology 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. Spotify Technology 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 year, Spotify Technology 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 Spotify Technology's liabilities, but we can be reassured by the fact it has has net cash of €3.06b. And it impressed us with free cash flow of €823m, being 340% of its EBIT. So we don't think Spotify Technology's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Spotify Technology has 1 warning sign we think you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.