Is Eton Pharmaceuticals (NASDAQ:ETON) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Eton Pharmaceuticals, Inc. (NASDAQ:ETON) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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.

View our latest analysis for Eton Pharmaceuticals

How Much Debt Does Eton Pharmaceuticals Carry?

The chart below, which you can click on for greater detail, shows that Eton Pharmaceuticals had US$6.39m in debt in September 2022; about the same as the year before. However, its balance sheet shows it holds US$13.4m in cash, so it actually has US$6.99m net cash.

A Look At Eton Pharmaceuticals' Liabilities

According to the last reported balance sheet, Eton Pharmaceuticals had liabilities of US$4.66m due within 12 months, and liabilities of US$5.68m due beyond 12 months. On the other hand, it had cash of US$13.4m and US$1.50m worth of receivables due within a year. So it actually has US$4.54m more liquid assets than total liabilities.

This short term liquidity is a sign that Eton Pharmaceuticals could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Eton Pharmaceuticals has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Eton Pharmaceuticals'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.

In the last year Eton Pharmaceuticals wasn't profitable at an EBIT level, but managed to grow its revenue by 19%, to US$19m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

So How Risky Is Eton Pharmaceuticals?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Eton Pharmaceuticals lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$9.2m and booked a US$8.9m accounting loss. Given it only has net cash of US$6.99m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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 3 warning signs we've spotted with Eton Pharmaceuticals .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.