Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, CoStar Group, Inc. (NASDAQ:CSGP) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is CoStar Group's Net Debt?

As you can see below, CoStar Group had US$991.5m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has US$4.94b in cash, leading to a US$3.95b net cash position.

How Strong Is CoStar Group's Balance Sheet?

The latest balance sheet data shows that CoStar Group had liabilities of US$539.4m due within a year, and liabilities of US$1.11b falling due after that. Offsetting these obligations, it had cash of US$4.94b as well as receivables valued at US$184.5m due within 12 months. So it can boast US$3.47b more liquid assets than total liabilities.

This surplus suggests that CoStar Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, CoStar Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact CoStar Group's saving grace is its low debt levels, because its EBIT has tanked 90% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CoStar Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. CoStar Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, CoStar Group produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that CoStar Group has net cash of US$3.95b, as well as more liquid assets than liabilities. The cherry on top was that in converted 69% of that EBIT to free cash flow, bringing in -US$179m. So we don't have any problem with CoStar Group's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for CoStar Group you should be aware of.

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.