Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that Lam Research Corporation (NASDAQ:LRCX) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Lam Research's Net Debt?

As you can see below, Lam Research had US$4.98b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$5.85b in cash offsetting this, leading to net cash of US$864.5m.

How Strong Is Lam Research's Balance Sheet?

We can see from the most recent balance sheet that Lam Research had liabilities of US$4.34b falling due within a year, and liabilities of US$5.87b due beyond that. On the other hand, it had cash of US$5.85b and US$2.52b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.84b.

This state of affairs indicates that Lam Research's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$110.2b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Lam Research boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Lam Research's EBIT dived 18%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lam Research's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Lam Research 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, Lam Research recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

We could understand if investors are concerned about Lam Research's liabilities, but we can be reassured by the fact it has has net cash of US$864.5m. And it impressed us with free cash flow of US$4.3b, being 77% of its EBIT. So we are not troubled with Lam Research's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Lam Research, you may well want to click here to check an interactive graph of its earnings per share history.

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.