Cadence Design Systems (NASDAQ:CDNS) Could Easily Take On More Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Cadence Design Systems, Inc. (NASDAQ:CDNS) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Cadence Design Systems

What Is Cadence Design Systems's Net Debt?

The chart below, which you can click on for greater detail, shows that Cadence Design Systems had US$348.0m in debt in July 2022; about the same as the year before. However, it does have US$1.03b in cash offsetting this, leading to net cash of US$681.5m.

A Look At Cadence Design Systems' Liabilities

We can see from the most recent balance sheet that Cadence Design Systems had liabilities of US$1.04b falling due within a year, and liabilities of US$693.6m due beyond that. On the other hand, it had cash of US$1.03b and US$415.0m worth of receivables due within a year. So its liabilities total US$291.5m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Cadence Design Systems' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$44.5b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Cadence Design Systems boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Cadence Design Systems grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Cadence Design Systems 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Cadence Design Systems 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 three years, Cadence Design Systems actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Cadence Design Systems has US$681.5m in net cash. And it impressed us with free cash flow of US$1.1b, being 119% of its EBIT. So is Cadence Design Systems's debt a risk? It doesn't seem so to us. We'd be very excited to see if Cadence Design Systems insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.