These 4 Measures Indicate That Gap (NYSE:GAP) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies The Gap, Inc. (NYSE:GAP) makes use of debt. But the more important question is: how much risk is that debt creating?

AI is about to change healthcare. These 20 stocks are working on everything from early diagnostics to drug discovery. The best part - they are all under $10bn in marketcap - there is still time to get in early.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Gap Carry?

The chart below, which you can click on for greater detail, shows that Gap had US$1.49b in debt in February 2025; about the same as the year before. However, its balance sheet shows it holds US$2.59b in cash, so it actually has US$1.10b net cash.

A Look At Gap's Liabilities

According to the last reported balance sheet, Gap had liabilities of US$3.26b due within 12 months, and liabilities of US$5.37b due beyond 12 months. Offsetting this, it had US$2.59b in cash and US$301.0m in receivables that were due within 12 months. So its liabilities total US$5.73b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$6.69b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Gap also has more cash than debt, so we're pretty confident it can manage its debt safely.

Check out our latest analysis for Gap

On top of that, Gap grew its EBIT by 85% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Gap'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 .

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Gap 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. Over the last two years, Gap actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Gap's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$1.10b. And it impressed us with free cash flow of US$1.0b, being 125% of its EBIT. So we don't think Gap's use of debt is risky. 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 1 warning sign we've spotted with Gap .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.