Warren Buffett famously said, '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. As with many other companies Cadence Design Systems, Inc. (NASDAQ:CDNS) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Cadence Design Systems's Net Debt?
As you can see below, Cadence Design Systems had US$199.2m of debt at April 2021, down from US$696.2m a year prior. However, its balance sheet shows it holds US$743.0m in cash, so it actually has US$543.8m net cash.
How Healthy Is Cadence Design Systems' Balance Sheet?
The latest balance sheet data shows that Cadence Design Systems had liabilities of US$792.3m due within a year, and liabilities of US$664.2m falling due after that. Offsetting these obligations, it had cash of US$743.0m as well as receivables valued at US$395.6m due within 12 months. So it has liabilities totalling US$317.9m more than its cash and near-term receivables, combined.
This state of affairs indicates that Cadence Design Systems' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$40.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Cadence Design Systems boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Cadence Design Systems grew its EBIT by 41% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Cadence Design Systems 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Cadence Design Systems 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, Cadence Design Systems 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 Cadence Design Systems has US$543.8m in net cash. The cherry on top was that in converted 122% of that EBIT to free cash flow, bringing in US$806m. So is Cadence Design Systems'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 1 warning sign for Cadence Design Systems you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
