Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that Verona Pharma plc (NASDAQ:VRNA) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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 examine debt levels, we first consider both cash and debt levels, together.

What Is Verona Pharma's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Verona Pharma had debt of US$119.7m, up from US$19.9m in one year. But on the other hand it also has US$404.6m in cash, leading to a US$284.9m net cash position.

A Look At Verona Pharma's Liabilities

According to the last reported balance sheet, Verona Pharma had liabilities of US$48.3m due within 12 months, and liabilities of US$217.5m due beyond 12 months. Offsetting this, it had US$404.6m in cash and US$3.68m in receivables that were due within 12 months. So it can boast US$142.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Verona Pharma could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Verona Pharma 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 Verona Pharma 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 Verona Pharma can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.

So How Risky Is Verona Pharma?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Verona Pharma had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of US$54m and booked a US$125m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of US$284.9m. 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Verona Pharma (1 is concerning) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.