Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. As with many other companies EPAM Systems, Inc. (NYSE:EPAM) makes use of debt. But is this debt a concern to shareholders?

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

How Much Debt Does EPAM Systems Carry?

The chart below, which you can click on for greater detail, shows that EPAM Systems had US$25.0m in debt in September 2021; about the same as the year before. But on the other hand it also has US$1.27b in cash, leading to a US$1.24b net cash position.

A Look At EPAM Systems’ Liabilities

We can see from the most recent balance sheet that EPAM Systems had liabilities of US$632.5m falling due within a year, and liabilities of US$270.6m due beyond that. Offsetting this, it had US$1.27b in cash and US$755.6m in receivables that were due within 12 months. So it actually has US$1.12b more liquid assets than total liabilities.

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

In addition to that, we’re happy to report that EPAM Systems has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine EPAM Systems’s ability to maintain a healthy balance sheet going forward.

Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. EPAM Systems 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. Over the last three years, EPAM Systems recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that EPAM Systems has net cash of US$1.24b, as well as more liquid assets than liabilities. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in US$374m. So we don’t think EPAM Systems’s use of debt is risky.