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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Cognizant Technology Solutions Corporation (NASDAQ:CTSH) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at 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$646.0m in debt in December 2022; about the same as the year before. However, it does have US$2.50b in cash offsetting this, leading to net cash of US$1.86b.

A Look At Cognizant Technology Solutions' Liabilities

According to the last reported balance sheet, Cognizant Technology Solutions had liabilities of US$3.35b due within 12 months, and liabilities of US$2.20b due beyond 12 months. On the other hand, it had cash of US$2.50b and US$3.80b worth of receivables due within a year. So it can boast US$754.0m 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.

Fortunately, Cognizant Technology Solutions grew its EBIT by 5.7% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Cognizant Technology Solutions can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. During the last three years, Cognizant Technology Solutions generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Cognizant Technology Solutions has US$1.86b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in US$2.2b. So is Cognizant Technology Solutions's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Cognizant Technology Solutions you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.