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We Think Ironwood Pharmaceuticals (NASDAQ:IRWD) Can Manage Its Debt With Ease

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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 can see that Ironwood Pharmaceuticals, Inc. (NASDAQ:IRWD) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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 Ironwood Pharmaceuticals

What Is Ironwood Pharmaceuticals's Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Ironwood Pharmaceuticals had debt of US$436.1m, up from US$413.4m in one year. But it also has US$438.5m in cash to offset that, meaning it has US$2.39m net cash.

debt-equity-history-analysis
debt-equity-history-analysis

A Look At Ironwood Pharmaceuticals' Liabilities

According to the last reported balance sheet, Ironwood Pharmaceuticals had liabilities of US$23.6m due within 12 months, and liabilities of US$465.5m due beyond 12 months. On the other hand, it had cash of US$438.5m and US$87.2m worth of receivables due within a year. So it actually has US$36.5m more liquid assets than total liabilities.

This state of affairs indicates that Ironwood Pharmaceuticals' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$2.08b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Ironwood Pharmaceuticals boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Ironwood Pharmaceuticals grew its EBIT by 28% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ironwood Pharmaceuticals's ability to maintain a healthy balance sheet going forward. 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. While Ironwood 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. During the last three years, Ironwood Pharmaceuticals produced sturdy free cash flow equating to 59% 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 Ironwood Pharmaceuticals has US$2.39m in net cash and a decent-looking balance sheet. And we liked the look of last year's 28% year-on-year EBIT growth. 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 instance, we've identified 1 warning sign for Ironwood Pharmaceuticals that you should be aware of.

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.

This article by Simply Wall St is general in nature. 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.

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