The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, Synopsys, Inc. (NASDAQ:SNPS) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is Synopsys's Debt?

As you can see below, Synopsys had US$15.6m of debt at July 2024, down from US$18.2m a year prior. However, its balance sheet shows it holds US$1.99b in cash, so it actually has US$1.98b net cash.

How Strong Is Synopsys' Balance Sheet?

The latest balance sheet data shows that Synopsys had liabilities of US$2.53b due within a year, and liabilities of US$1.37b falling due after that. Offsetting this, it had US$1.99b in cash and US$1.50b in receivables that were due within 12 months. So its liabilities total US$410.0m more than the combination of its cash and short-term receivables.

Having regard to Synopsys' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$85.7b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Synopsys also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Synopsys grew its EBIT by 33% 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 Synopsys can strengthen its balance sheet over time. 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 Synopsys 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 last three years, Synopsys actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Synopsys has US$1.98b in net cash. The cherry on top was that in converted 111% of that EBIT to free cash flow, bringing in US$998m. So is Synopsys's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Synopsys would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.