Yahoo Finance Paycom Software (NYSE:PAYC) Seems To Use Debt Quite Sensibly
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.' 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. Importantly, Paycom Software, Inc. (NYSE:PAYC) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Paycom Software
What Is Paycom Software's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Paycom Software had US$21.5m of debt in June 2020, down from US$33.5m, one year before. However, it does have US$113.5m in cash offsetting this, leading to net cash of US$92.1m.
How Strong Is Paycom Software's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Paycom Software had liabilities of US$1.12b due within 12 months and liabilities of US$218.4m due beyond that. Offsetting these obligations, it had cash of US$113.5m as well as receivables valued at US$13.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.2b.
Since publicly traded Paycom Software shares are worth a very impressive total of US$16.1b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Paycom Software boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Paycom Software grew its EBIT by 16% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Paycom Software can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Paycom Software 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. Over the most recent three years, Paycom Software recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing up
While it is always sensible to look at a company's total liabilities, it is very reassuring that Paycom Software has US$92.1m in net cash. And we liked the look of last year's 16% year-on-year EBIT growth. So is Paycom Software's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Paycom Software you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
This article by Simply Wall St is general in nature. 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.
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