Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 note that Cognizant Technology Solutions Corporation (NASDAQ:CTSH) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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.

How Much Debt Does Cognizant Technology Solutions Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Cognizant Technology Solutions had debt of US$1.22b, up from US$647.0m in one year. However, its balance sheet shows it holds US$2.03b in cash, so it actually has US$809.0m net cash.

How Healthy Is Cognizant Technology Solutions' Balance Sheet?

According to the last reported balance sheet, Cognizant Technology Solutions had liabilities of US$3.39b due within 12 months, and liabilities of US$2.32b due beyond 12 months. On the other hand, it had cash of US$2.03b and US$4.21b worth of receivables due within a year. So it actually has US$519.0m more liquid assets than total liabilities.

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 while it's hard to imagine that the US$39.7b company is struggling for cash, we still think it's worth monitoring its 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.

The good news is that Cognizant Technology Solutions has increased its EBIT by 2.7% over twelve months, which should ease any concerns about debt repayment. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Cognizant Technology Solutions has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Cognizant Technology Solutions recorded free cash flow worth 67% 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 it is always sensible to investigate a company's debt, in this case Cognizant Technology Solutions has US$809.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$1.6b, being 67% of its EBIT. So is Cognizant Technology Solutions's debt a risk? It doesn't seem so to us. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Cognizant Technology Solutions insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.

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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.