These 4 Measures Indicate That Cosmo Pharmaceuticals (VTX:COPN) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Cosmo Pharmaceuticals N.V. (VTX:COPN) does carry debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Cosmo Pharmaceuticals

What Is Cosmo Pharmaceuticals's Debt?

The chart below, which you can click on for greater detail, shows that Cosmo Pharmaceuticals had €165.2m in debt in June 2021; about the same as the year before. But it also has €203.1m in cash to offset that, meaning it has €37.9m net cash.

A Look At Cosmo Pharmaceuticals' Liabilities

We can see from the most recent balance sheet that Cosmo Pharmaceuticals had liabilities of €16.3m falling due within a year, and liabilities of €175.5m due beyond that. Offsetting this, it had €203.1m in cash and €22.0m in receivables that were due within 12 months. So it actually has €33.4m more liquid assets than total liabilities.

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

It is well worth noting that Cosmo Pharmaceuticals's EBIT shot up like bamboo after rain, gaining 97% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Cosmo 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Cosmo 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. During the last two years, Cosmo Pharmaceuticals produced sturdy free cash flow equating to 58% 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 it is always sensible to investigate a company's debt, in this case Cosmo Pharmaceuticals has €37.9m in net cash and a decent-looking balance sheet. And we liked the look of last year's 97% year-on-year EBIT growth. So we don't think Cosmo Pharmaceuticals's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Cosmo Pharmaceuticals .

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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