Synopsys (NASDAQ:SNPS) Seems To Use Debt Rather Sparingly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Synopsys, Inc. (NASDAQ:SNPS) makes use of debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Synopsys

What Is Synopsys's Debt?

As you can see below, Synopsys had US$115.6m of debt at April 2021, down from US$235.8m a year prior. But on the other hand it also has US$1.46b in cash, leading to a US$1.34b net cash position.

How Healthy Is Synopsys' Balance Sheet?

According to the last reported balance sheet, Synopsys had liabilities of US$2.26b due within 12 months, and liabilities of US$991.4m due beyond 12 months. Offsetting these obligations, it had cash of US$1.46b as well as receivables valued at US$887.9m due within 12 months. So it has liabilities totalling US$901.3m more than its cash and near-term receivables, combined.

Given Synopsys has a humongous market capitalization of US$42.4b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Synopsys also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Synopsys grew its EBIT by 38% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Synopsys 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Synopsys 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. Happily for any shareholders, Synopsys actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Synopsys has US$1.34b in net cash. The cherry on top was that in converted 143% of that EBIT to free cash flow, bringing in US$1.2b. So is Synopsys's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Synopsys would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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