Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say this when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We notice that Adobe Inc. (NASDAQ: ADBE) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, many companies use debt to finance their growth without negative consequences. When we look at debt levels, we first look at cash and debt levels, together.
Check out our latest analysis for Adobe
What is Adobe’s debt?
As you can see below, Adobe had $ 4.12 billion in debt in December 2021, which is roughly the same as the year before. You can click on the graph for more details. But it also has $ 5.80 billion in cash to make up for that, which means it has $ 1.68 billion in net cash.
Is Adobe’s track record healthy?
The latest balance sheet data shows that Adobe had liabilities of US $ 6.93 billion due within one year, and liabilities of US $ 5.51 billion due thereafter. In return, he had $ 5.80 billion in cash and $ 1.88 billion in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 4.77 billion.
Considering Adobe’s size, it seems its liquid assets are well balanced with its total liabilities. So while it’s hard to imagine the US $ 243.0 billion company chasing cash, we still think it’s worth watching its balance sheet. While it has some liabilities to note, Adobe also has more cash than debt, so we’re pretty confident it can handle its debt safely.
On top of that, Adobe has increased its EBIT by 36% over the past twelve months, and this growth will make it easier to process its debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Adobe can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, a business can only pay off its debts with hard cash, not with book profits. Adobe may have net cash on the balance sheet, but it’s always interesting to consider how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Over the past three years, Adobe has actually generated more free cash flow than EBIT. This kind of solid silver generation warms our hearts like a puppy in a bumblebee costume.
In summary
While it always makes sense to look at a company’s total liabilities, it’s very reassuring that Adobe has $ 1.68 billion in net cash. The icing on the cake was that he converted 120% of that EBIT into free cash flow, bringing in US $ 6.6 billion. So, is Adobe’s debt a risk? It does not seem to us. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. We have identified 1 warning sign with Adobe and understanding them should be part of your investment process.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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