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 Spotify Technology S.A. (NYSE:SPOT) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Spotify Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Spotify Technology had debt of €1.32b, up from €1.17b in one year. But on the other hand it also has €4.95b in cash, leading to a €3.63b net cash position.

A Look At Spotify Technology's Liabilities

According to the last reported balance sheet, Spotify Technology had liabilities of €4.06b due within 12 months, and liabilities of €1.83b due beyond 12 months. Offsetting this, it had €4.95b in cash and €788.0m in receivables that were due within 12 months. So it has liabilities totalling €149.0m more than its cash and near-term receivables, combined.

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 €62.4b 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 €709m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Spotify Technology'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Spotify Technology 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. Happily for any shareholders, Spotify Technology actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Spotify Technology has €3.63b in net cash. And it impressed us with free cash flow of €1.3b, being 184% of its EBIT. So is Spotify Technology's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Spotify Technology .

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.