Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies COMPASS Pathways plc (NASDAQ:CMPS) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is COMPASS Pathways's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 COMPASS Pathways had debt of US$29.8m, up from US$28.4m in one year. However, it does have US$207.0m in cash offsetting this, leading to net cash of US$177.2m.

How Strong Is COMPASS Pathways' Balance Sheet?

We can see from the most recent balance sheet that COMPASS Pathways had liabilities of US$26.2m falling due within a year, and liabilities of US$28.1m due beyond that. On the other hand, it had cash of US$207.0m and US$13.0m worth of receivables due within a year. So it can boast US$165.7m more liquid assets than total liabilities.

This luscious liquidity implies that COMPASS Pathways' balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that COMPASS Pathways has more cash than debt is arguably a good indication that it can manage its debt safely. 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 COMPASS Pathways 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.

Given its lack of meaningful operating revenue, COMPASS Pathways shareholders no doubt hope it can fund itself until it has a profitable product.

So How Risky Is COMPASS Pathways?

Statistically speaking companies that lose money are riskier than those that make money. And we do note that COMPASS Pathways 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$105m and booked a US$144m accounting loss. However, it has net cash of US$177.2m, so it has a bit of time before it will need more capital. 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. However, not all investment risk resides within the balance sheet - far from it. Be aware that COMPASS Pathways is showing 4 warning signs in our investment analysis , and 1 of those is significant...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.