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 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. Importantly, Ironwood Pharmaceuticals, Inc. (NASDAQ:IRWD) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ironwood Pharmaceuticals

What Is Ironwood Pharmaceuticals's Debt?

The image below, which you can click on for greater detail, shows that Ironwood Pharmaceuticals had debt of US$395.9m at the end of September 2022, a reduction from US$448.0m over a year. But on the other hand it also has US$574.2m in cash, leading to a US$178.3m net cash position.

How Strong Is Ironwood Pharmaceuticals' Balance Sheet?

We can see from the most recent balance sheet that Ironwood Pharmaceuticals had liabilities of US$27.1m falling due within a year, and liabilities of US$422.2m due beyond that. On the other hand, it had cash of US$574.2m and US$116.5m worth of receivables due within a year. So it actually has US$241.5m more liquid assets than total liabilities.

This surplus suggests that Ironwood Pharmaceuticals has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Ironwood Pharmaceuticals has more cash than debt is arguably a good indication that it can manage its debt safely.

Ironwood Pharmaceuticals'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. 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 Ironwood Pharmaceuticals can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Ironwood Pharmaceuticals 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, Ironwood Pharmaceuticals actually produced more free cash flow than EBIT. 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 we empathize with investors who find debt concerning, you should keep in mind that Ironwood Pharmaceuticals has net cash of US$178.3m, as well as more liquid assets than liabilities. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in US$259m. So we don't think Ironwood Pharmaceuticals'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. For example - Ironwood Pharmaceuticals has 2 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.