Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Evoke Pharma, Inc. (NASDAQ:EVOK) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 Evoke Pharma’s Net Debt?

The chart below, which you can click on for greater detail, shows that Evoke Pharma had US$5.00m in debt in September 2022; about the same as the year before. However, it does have US$12.4m in cash offsetting this, leading to net cash of US$7.35m.

How Strong Is Evoke Pharma’s Balance Sheet?

According to the last reported balance sheet, Evoke Pharma had liabilities of US$1.88m due within 12 months, and liabilities of US$6.00m due beyond 12 months. Offsetting these obligations, it had cash of US$12.4m as well as receivables valued at US$675.0k due within 12 months. So it can boast US$5.15m more liquid assets than total liabilities.

This surplus strongly suggests that Evoke Pharma has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Evoke 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 Evoke Pharma can strengthen its balance sheet over time.

Over 12 months, Evoke Pharma reported revenue of US$2.1m, which is a gain of 62%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Evoke Pharma?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Evoke Pharma lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through US$6.1m of cash and made a loss of US$8.1m. With only US$7.35m on the balance sheet, it would appear that its going to need to raise capital again soon. Evoke Pharma’s revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. Pre-profit companies are often risky, but they can also offer great rewards.