These 4 Measures Indicate That Ligand Pharmaceuticals (NASDAQ:LGND) 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Ligand Pharmaceuticals Incorporated (NASDAQ:LGND) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Ligand Pharmaceuticals

How Much Debt Does Ligand Pharmaceuticals Carry?

As you can see below, Ligand Pharmaceuticals had US$76.6m of debt at September 2022, down from US$316.9m a year prior. But it also has US$121.4m in cash to offset that, meaning it has US$44.8m net cash.

A Look At Ligand Pharmaceuticals' Liabilities

According to the last reported balance sheet, Ligand Pharmaceuticals had liabilities of US$135.2m due within 12 months, and liabilities of US$99.1m due beyond 12 months. Offsetting these obligations, it had cash of US$121.4m as well as receivables valued at US$66.0m due within 12 months. So its liabilities total US$46.9m more than the combination of its cash and short-term receivables.

Since publicly traded Ligand Pharmaceuticals shares are worth a total of US$1.29b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Ligand Pharmaceuticals boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Ligand Pharmaceuticals's EBIT fell a jaw-dropping 92% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Ligand 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. While Ligand Pharmaceuticals has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Ligand Pharmaceuticals actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ligand Pharmaceuticals has US$44.8m in net cash. And it impressed us with free cash flow of US$95m, being 352% of its EBIT. So we are not troubled with Ligand Pharmaceuticals's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Ligand Pharmaceuticals you should know about.

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.