Cognizant Technology Solutions (NASDAQ:CTSH) Has A Pretty 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 note that Cognizant Technology Solutions Corporation (NASDAQ:CTSH) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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, 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Cognizant Technology Solutions

What Is Cognizant Technology Solutions's Net Debt?

The chart below, which you can click on for greater detail, shows that Cognizant Technology Solutions had US$623.0m in debt in June 2024; about the same as the year before. But on the other hand it also has US$2.21b in cash, leading to a US$1.58b net cash position.

A Look At Cognizant Technology Solutions' Liabilities

We can see from the most recent balance sheet that Cognizant Technology Solutions had liabilities of US$2.95b falling due within a year, and liabilities of US$1.74b due beyond that. Offsetting this, it had US$2.21b in cash and US$3.97b in receivables that were due within 12 months. So it actually has US$1.50b more liquid assets than total liabilities.

This surplus suggests that Cognizant Technology Solutions has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Cognizant Technology Solutions has more cash than debt is arguably a good indication that it can manage its debt safely.

Cognizant Technology Solutions's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 Cognizant Technology Solutions'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. Cognizant Technology Solutions 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 most recent three years, Cognizant Technology Solutions recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Cognizant Technology Solutions has US$1.58b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$1.6b, being 69% of its EBIT. So is Cognizant Technology Solutions's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Cognizant Technology Solutions is showing 1 warning sign in our investment analysis , 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.