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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Cognizant Technology Solutions Corporation (NASDAQ:CTSH) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Cognizant Technology Solutions's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Cognizant Technology Solutions had US$908.0m of debt, an increase on US$639.0m, over one year. But it also has US$2.24b in cash to offset that, meaning it has US$1.34b net cash.

How Healthy Is Cognizant Technology Solutions' Balance Sheet?

According to the last reported balance sheet, Cognizant Technology Solutions had liabilities of US$3.59b due within 12 months, and liabilities of US$1.97b due beyond 12 months. On the other hand, it had cash of US$2.24b and US$4.06b worth of receivables due within a year. So it actually has US$744.0m 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 it's very unlikely that the US$39.6b company is short on cash, but still worth keeping an eye on the 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.

Fortunately, Cognizant Technology Solutions grew its EBIT by 3.1% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Cognizant Technology Solutions 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Cognizant Technology Solutions 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. During the last three years, Cognizant Technology Solutions produced sturdy free cash flow equating to 68% 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 we empathize with investors who find debt concerning, you should keep in mind that Cognizant Technology Solutions has net cash of US$1.34b, as well as more liquid assets than liabilities. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in US$1.8b. So we don't think Cognizant Technology Solutions's use of debt is risky. 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.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.