David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Cadence Design Systems, Inc. (NASDAQ:CDNS) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Cadence Design Systems Carry?
The image below, which you can click on for greater detail, shows that Cadence Design Systems had debt of US$347.4m at the end of October 2021, a reduction from US$696.6m over a year. However, its balance sheet shows it holds US$1.01b in cash, so it actually has US$666.4m net cash.
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$907.2m due within 12 months and liabilities of US$675.4m due beyond that. On the other hand, it had cash of US$1.01b and US$335.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$233.8m.
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$50.7b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Cadence Design Systems also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that Cadence Design Systems has boosted its EBIT by 34%, thus reducing the spectre of future debt repayments. 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.
Finally, while the tax-man may adore accounting profits, lenders only accept 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. Over the last three years, Cadence Design Systems actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
We could understand if investors are concerned about Cadence Design Systems's liabilities, but we can be reassured by the fact it has has net cash of US$666.4m. The cherry on top was that in converted 129% of that EBIT to free cash flow, bringing in US$940m. So we don't think Cadence Design Systems'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. For instance, we've identified 1 warning sign for Cadence Design Systems that you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.