Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Cognizant Technology Solutions Carry?

As you can see below, Cognizant Technology Solutions had US$623.0m of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has US$2.21b in cash to offset that, meaning it has US$1.58b net cash.

How Healthy Is Cognizant Technology Solutions' Balance Sheet?

We can see from the most recent balance sheet that Cognizant Technology Solutions had liabilities of US$2.95b falling due within a year, and liabilities of US$1.74b due beyond that. On the other hand, it had cash of US$2.21b and US$3.97b worth of receivables due within a year. So it can boast US$1.50b more liquid assets than total liabilities.

This short term liquidity is a sign that Cognizant Technology Solutions could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Cognizant Technology Solutions boasts net cash, so it's fair to say it does not have a heavy debt load!

Cognizant Technology Solutions's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 69% 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$1.58b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$1.6b, being 69% of its EBIT. So we don't think Cognizant Technology Solutions's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Cognizant Technology Solutions you should be aware of.

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.