We Think Cognizant Technology Solutions (NASDAQ:CTSH) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Cognizant Technology Solutions Corporation (NASDAQ:CTSH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Cognizant Technology Solutions

What Is Cognizant Technology Solutions's Net Debt?

As you can see below, Cognizant Technology Solutions had US$647.0m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$2.37b in cash offsetting this, leading to net cash of US$1.72b.

How Strong Is Cognizant Technology Solutions' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cognizant Technology Solutions had liabilities of US$3.19b due within 12 months and liabilities of US$2.01b due beyond that. Offsetting this, it had US$2.37b in cash and US$3.81b in receivables that were due within 12 months. So it can boast US$978.0m 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. 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.

But the other side of the story is that Cognizant Technology Solutions saw its EBIT decline by 3.5% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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'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. Over the most recent three years, Cognizant Technology Solutions recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

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$1.72b, as well as more liquid assets than liabilities. The cherry on top was that in converted 77% of that EBIT to free cash flow, bringing in US$2.0b. So is Cognizant Technology Solutions's debt a risk? It doesn't seem so to us. We'd be motivated to research the stock further if we found out that Cognizant Technology Solutions insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.

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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.