Is Cognizant Technology Solutions (NASDAQ:CTSH) Using Too Much Debt?

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. 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?

Why Does Debt Bring Risk?

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. 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. 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 Debt?

You can click the graphic below for the historical numbers, but it shows that Cognizant Technology Solutions had US$655.0m of debt in March 2022, down from US$692.0m, one year before. However, it does have US$2.32b in cash offsetting this, leading to net cash of US$1.66b.

How Strong Is Cognizant Technology Solutions' Balance Sheet?

According to the last reported balance sheet, Cognizant Technology Solutions had liabilities of US$3.19b due within 12 months, and liabilities of US$2.28b due beyond 12 months. Offsetting this, it had US$2.32b in cash and US$4.03b in receivables that were due within 12 months. So it can boast US$888.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Cognizant Technology Solutions could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Cognizant Technology Solutions boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Cognizant Technology Solutions grew its EBIT at 19% over the last year, further increasing its ability to manage debt. 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 Cognizant Technology Solutions'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 company can only pay off debt with cold hard cash, not accounting profits. 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 89% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

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$1.66b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$2.3b, being 89% of its EBIT. 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. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Cognizant Technology Solutions you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.