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. 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 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Cognizant Technology Solutions's Net Debt?

The chart below, which you can click on for greater detail, shows that Cognizant Technology Solutions had US$639.0m in debt in December 2023; about the same as the year before. However, it does have US$2.64b in cash offsetting this, leading to net cash of US$2.00b.

How Healthy Is Cognizant Technology Solutions' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cognizant Technology Solutions had liabilities of US$3.33b due within 12 months and liabilities of US$1.92b due beyond that. Offsetting this, it had US$2.64b in cash and US$4.17b in receivables that were due within 12 months. So it can boast US$1.54b more liquid assets than total liabilities.

This surplus suggests that Cognizant Technology Solutions has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Cognizant Technology Solutions boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Cognizant Technology Solutions saw its EBIT drop by 3.0% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder 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 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, a company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, Cognizant Technology Solutions produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Cognizant Technology Solutions has US$2.00b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$2.0b, being 74% of its EBIT. So is Cognizant Technology Solutions'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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Cognizant Technology Solutions that you should be aware of before investing here.

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.