Cognizant Technology Solutions (NASDAQ:CTSH) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Cognizant Technology Solutions Corporation (NASDAQ:CTSH) does use debt in its business. But the more important question is: how much risk is that debt creating?

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, 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.

Our analysis indicates that CTSH is potentially undervalued!

How Much Debt Does Cognizant Technology Solutions Carry?

You can click the graphic below for the historical numbers, but it shows that Cognizant Technology Solutions had US$646.0m of debt in June 2022, down from US$683.0m, one year before. But it also has US$2.32b in cash to offset that, meaning it has US$1.67b net cash.

A Look At Cognizant Technology Solutions' Liabilities

The latest balance sheet data shows that Cognizant Technology Solutions had liabilities of US$3.15b due within a year, and liabilities of US$2.16b falling due after that. On the other hand, it had cash of US$2.32b and US$4.16b worth of receivables due within a year. So it actually has US$1.18b 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. Succinctly put, Cognizant Technology Solutions boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Cognizant Technology Solutions grew its EBIT by 16% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 last three years, Cognizant Technology Solutions recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Cognizant Technology Solutions has net cash of US$1.67b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$2.3b, being 88% of its EBIT. So we don't think Cognizant Technology Solutions's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Cognizant Technology Solutions .

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.