Cognizant Technology Solutions (NASDAQ:CTSH) Has A Pretty Healthy Balance Sheet
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.' 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 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?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Debt?
The image below, which you can click on for greater detail, shows that Cognizant Technology Solutions had debt of US$692.0m at the end of March 2021, a reduction from US$2.47b over a year. But it also has US$2.16b in cash to offset that, meaning it has US$1.47b net cash.
How Strong Is Cognizant Technology Solutions' Balance Sheet?
The latest balance sheet data shows that Cognizant Technology Solutions had liabilities of US$3.15b due within a year, and liabilities of US$2.47b falling due after that. On the other hand, it had cash of US$2.16b and US$3.57b worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
This state of affairs indicates that Cognizant Technology Solutions' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$36.0b company is short on cash, but still worth keeping an eye on the balance sheet. 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 bad news is that Cognizant Technology Solutions has seen its EBIT plunge 17% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Cognizant Technology Solutions can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
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 88% of its EBIT, more than we'd 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$1.47b, as well as more liquid assets than liabilities. The cherry on top was that in converted 88% of that EBIT to free cash flow, bringing in US$2.6b. So we don't have any problem with Cognizant Technology Solutions's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs 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.
This article by Simply Wall St is general in nature. 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.
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