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.' 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 Sprout Social, Inc. (NASDAQ:SPT) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Sprout Social

How Much Debt Does Sprout Social Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Sprout Social had debt of US$75.0m, up from none in one year. However, its balance sheet shows it holds US$113.0m in cash, so it actually has US$38.0m net cash.

How Strong Is Sprout Social's Balance Sheet?

We can see from the most recent balance sheet that Sprout Social had liabilities of US$163.3m falling due within a year, and liabilities of US$92.1m due beyond that. Offsetting this, it had US$113.0m in cash and US$45.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$97.2m.

Since publicly traded Sprout Social shares are worth a total of US$3.03b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Sprout Social also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sprout Social'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.

Over 12 months, Sprout Social reported revenue of US$310m, which is a gain of 30%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Sprout Social?

Although Sprout Social had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of US$10m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. One positive is that Sprout Social is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But we still think it's somewhat risky. 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. To that end, you should learn about the 3 warning signs we've spotted with Sprout Social (including 1 which shouldn't be ignored) .

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.

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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.