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. Importantly, Pliant Therapeutics, Inc. (NASDAQ:PLRX) does carry debt. 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Pliant Therapeutics's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Pliant Therapeutics had US$30.1m of debt, an increase on US$9.99m, over one year. But on the other hand it also has US$436.6m in cash, leading to a US$406.5m net cash position.

How Healthy Is Pliant Therapeutics' Balance Sheet?

According to the last reported balance sheet, Pliant Therapeutics had liabilities of US$30.9m due within 12 months, and liabilities of US$60.1m due beyond 12 months. Offsetting this, it had US$436.6m in cash and US$2.80m in receivables that were due within 12 months. So it can boast US$348.4m more liquid assets than total liabilities.

This surplus liquidity suggests that Pliant Therapeutics' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Pliant Therapeutics boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Pliant Therapeutics 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.

It seems likely shareholders hope that Pliant Therapeutics can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.

So How Risky Is Pliant Therapeutics?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Pliant Therapeutics had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of US$140m and booked a US$185m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of US$406.5m. That means it could keep spending at its current rate for more than two years. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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. We've identified 4 warning signs with Pliant Therapeutics (at least 2 which are significant) , and understanding them should be part of your investment process.

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.