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. Importantly, Cadence Design Systems, Inc. (NASDAQ:CDNS) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Cadence Design Systems Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Cadence Design Systems had US$2.83b of debt, an increase on US$648.8m, over one year. However, it does have US$2.94b in cash offsetting this, leading to net cash of US$116.1m.

How Strong Is Cadence Design Systems' Balance Sheet?

We can see from the most recent balance sheet that Cadence Design Systems had liabilities of US$1.67b falling due within a year, and liabilities of US$2.93b due beyond that. Offsetting these obligations, it had cash of US$2.94b as well as receivables valued at US$612.3m due within 12 months. So it has liabilities totalling US$1.05b 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 it's very unlikely that the US$82.6b company is short on cash, but still worth keeping an eye on the 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!

And we also note warmly that Cadence Design Systems grew its EBIT by 11% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Cadence Design Systems's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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. Over the last three years, Cadence Design Systems recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

We could understand if investors are concerned about Cadence Design Systems's liabilities, but we can be reassured by the fact it has has net cash of US$116.1m. And it impressed us with free cash flow of US$952m, being 94% of its EBIT. So is Cadence Design Systems's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Cadence Design Systems, you may well want to click here to check an interactive graph of its earnings per share history.

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.