Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
The famous fund manager Li Lu famously observed, “The largest investment risk is not the volatility of prices, but whether you would suffer a permanent loss of capital.” Charlie Munger backed Li Lu. Therefore, it would appear that the smart money understands the importance of debt, which is frequently a role in bankruptcies, in determining how dangerous a company is. We observe that Apple Inc. (NASDAQ:AAPLbalance )’s sheet does show debt. The main query, though, is whether the company’s riskiness is increased by this debt.
As you can see below, Apple had US$120.0b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$51.5b, its net debt is less, at about US$68.5b. How Strong Is Apple’s Balance Sheet The latest balance sheet data shows that Apple had liabilities of US$127.5b due within a year, and liabilities of US$155.8b falling due after that. On the other hand, it had cash of US$51.5b and US$45.4b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$186.4b.
Since publicly traded Apple shares are worth a very impressive total of US$2.38t, it seems unlikely that this level of liabilities would be a major threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).