Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Rhythm Pharmaceuticals, Inc. (NASDAQ:RYTM) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Rhythm Pharmaceuticals's Debt?

As you can see below, at the end of June 2024, Rhythm Pharmaceuticals had US$108.4m of debt, up from none a year ago. Click the image for more detail. However, it does have US$319.1m in cash offsetting this, leading to net cash of US$210.8m.

How Healthy Is Rhythm Pharmaceuticals' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Rhythm Pharmaceuticals had liabilities of US$54.7m due within 12 months and liabilities of US$147.6m due beyond that. Offsetting this, it had US$319.1m in cash and US$17.6m in receivables that were due within 12 months. So it can boast US$134.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Rhythm Pharmaceuticals could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Rhythm Pharmaceuticals has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Rhythm Pharmaceuticals's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Rhythm Pharmaceuticals reported revenue of US$102m, which is a gain of 133%, although it did not report any earnings before interest and tax. So its pretty obvious shareholders are hoping for more growth!

So How Risky Is Rhythm Pharmaceuticals?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months Rhythm Pharmaceuticals lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$169m and booked a US$261m accounting loss. However, it has net cash of US$210.8m, so it has a bit of time before it will need more capital. The good news for shareholders is that Rhythm Pharmaceuticals has dazzling revenue growth, so there's a very good chance it can boost its free cash flow in the years to come. High growth pre-profit companies may well be risky, but they can also offer great rewards. 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. For example, we've discovered 1 warning sign for Rhythm Pharmaceuticals that you should be aware of before investing here.

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.