Cadence Design Systems (NASDAQ:CDNS) Has A Rock Solid Balance Sheet

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.' 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. We note that Cadence Design Systems, Inc. (NASDAQ:CDNS) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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.

View our latest analysis for Cadence Design Systems

What Is Cadence Design Systems's Net Debt?

As you can see below, Cadence Design Systems had US$347.6m of debt, at January 2022, 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$1.09b in cash, leading to a US$747.3m net cash position.

How Healthy Is Cadence Design Systems' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cadence Design Systems had liabilities of US$971.2m due within 12 months and liabilities of US$674.4m due beyond that. Offsetting this, it had US$1.09b in cash and US$344.4m in receivables that were due within 12 months. So its liabilities total US$206.3m 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 it's very unlikely that the US$39.5b 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!

Also good is that Cadence Design Systems grew its EBIT at 19% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Cadence Design Systems's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Cadence Design Systems has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Cadence Design Systems actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

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$747.3m in net cash. And it impressed us with free cash flow of US$1.0b, being 129% of its EBIT. So we don't think Cadence Design Systems's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Cadence Design Systems that you should be aware of before investing here.

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.