These 4 Measures Indicate That Ironwood Pharmaceuticals (NASDAQ:IRWD) Is Using Debt Safely

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. As with many other companies Ironwood Pharmaceuticals, Inc. (NASDAQ:IRWD) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Ironwood Pharmaceuticals

What Is Ironwood Pharmaceuticals's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Ironwood Pharmaceuticals had US$395.5m of debt in June 2022, down from US$442.0m, one year before. However, it does have US$504.4m in cash offsetting this, leading to net cash of US$108.9m.

A Look At Ironwood Pharmaceuticals' Liabilities

We can see from the most recent balance sheet that Ironwood Pharmaceuticals had liabilities of US$23.3m falling due within a year, and liabilities of US$419.5m due beyond that. On the other hand, it had cash of US$504.4m and US$102.4m worth of receivables due within a year. So it actually has US$163.9m 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.

Fortunately, Ironwood Pharmaceuticals grew its EBIT by 5.6% 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 ultimately the future profitability of the business will decide if Ironwood Pharmaceuticals can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. During the last three years, Ironwood Pharmaceuticals generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Ironwood Pharmaceuticals has US$108.9m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 98% of that EBIT to free cash flow, bringing in US$265m. So we don't think Ironwood Pharmaceuticals's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Ironwood Pharmaceuticals is showing 2 warning signs 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.

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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.