Does Cadence Design Systems (NASDAQ:CDNS) Have A Healthy 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.' 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 should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Cadence Design Systems

How Much Debt Does Cadence Design Systems Carry?

As you can see below, Cadence Design Systems had US$347.8m of debt, at April 2022, which is about the same as the year before. You can click the chart for greater detail. But it also has US$1.13b in cash to offset that, meaning it has US$787.0m net cash.

How Healthy Is Cadence Design Systems' Balance Sheet?

According to the last reported balance sheet, Cadence Design Systems had liabilities of US$960.8m due within 12 months, and liabilities of US$674.1m due beyond 12 months. Offsetting this, it had US$1.13b in cash and US$380.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$119.3m.

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$42.6b 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 positive, Cadence Design Systems grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. 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'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. 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. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

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$787.0m in net cash. The cherry on top was that in converted 125% of that EBIT to free cash flow, bringing in US$1.2b. 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. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Cadence Design Systems you should know about.

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.