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

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 note that Cadence Design Systems, Inc. (NASDAQ:CDNS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Cadence Design Systems

How Much Debt Does Cadence Design Systems Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Cadence Design Systems had debt of US$1.35b, up from US$648.6m in one year. On the flip side, it has US$1.23b in cash leading to net debt of about US$120.0m.

How Strong Is Cadence Design Systems' Balance Sheet?

According to the last reported balance sheet, Cadence Design Systems had liabilities of US$1.53b due within 12 months, and liabilities of US$1.43b due beyond 12 months. Offsetting this, it had US$1.23b in cash and US$590.3m in receivables that were due within 12 months. So its liabilities total US$1.15b more than the combination of its cash and short-term receivables.

Having regard to Cadence Design Systems' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$75.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Cadence Design Systems has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

Cadence Design Systems has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.088 and EBIT of 222 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. The good news is that Cadence Design Systems has increased its EBIT by 9.0% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Cadence Design Systems can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Cadence Design Systems generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Cadence Design Systems's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Overall, we don't think Cadence Design Systems is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. Over time, share prices tend to follow earnings per share, so if you're interested in Cadence Design Systems, you may well want to click here to check an interactive graph of its earnings per share history.

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.