Is Cadence Design Systems (NASDAQ:CDNS) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Cadence Design Systems, Inc. (NASDAQ:CDNS) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Cadence Design Systems

What Is Cadence Design Systems's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Cadence Design Systems had US$586.1m of debt, an increase on US$345.7m, over one year. However, it does have US$1.19b in cash offsetting this, leading to net cash of US$603.1m.

A Look At Cadence Design Systems's Liabilities

Zooming in on the latest balance sheet data, we can see that Cadence Design Systems had liabilities of US$1.15b due within 12 months and liabilities of US$591.0m due beyond that. Offsetting this, it had US$1.19b in cash and US$323.0m in receivables that were due within 12 months. So it has liabilities totalling US$230.7m more than its cash and near-term receivables, combined.

This state of affairs indicates that Cadence Design Systems's 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$28.5b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Cadence Design Systems also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Cadence Design Systems grew its EBIT by 8.0% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Cadence Design Systems 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. Happily for any shareholders, Cadence Design Systems actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Cadence Design Systems has US$603.1m in net cash. The cherry on top was that in converted 138% of that EBIT to free cash flow, bringing in US$773m. So is Cadence Design Systems'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. However, not all investment risk resides within the balance sheet - far from it. Be aware that Cadence Design Systems is showing 1 warning sign in our investment analysis , you should know about...

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.

This article by Simply Wall St is general in nature. 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.

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