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 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 note that Zhejiang Yasha Decoration Co.,Ltd (SZSE:002375) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is Zhejiang Yasha DecorationLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Zhejiang Yasha DecorationLtd had CN¥1.54b of debt in March 2024, down from CN¥2.07b, one year before. However, its balance sheet shows it holds CN¥1.79b in cash, so it actually has CN¥252.6m net cash.

How Healthy Is Zhejiang Yasha DecorationLtd's Balance Sheet?

The latest balance sheet data shows that Zhejiang Yasha DecorationLtd had liabilities of CN¥12.8b due within a year, and liabilities of CN¥105.9m falling due after that. On the other hand, it had cash of CN¥1.79b and CN¥11.7b worth of receivables due within a year. So it actually has CN¥567.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Zhejiang Yasha DecorationLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Zhejiang Yasha DecorationLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Zhejiang Yasha DecorationLtd grew its EBIT by 282% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is Zhejiang Yasha DecorationLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Zhejiang Yasha DecorationLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Zhejiang Yasha DecorationLtd actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Yasha DecorationLtd has CN¥252.6m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 106% of that EBIT to free cash flow, bringing in CN¥418m. So is Zhejiang Yasha DecorationLtd's debt a risk? It doesn't seem so to us. 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 instance, we've identified 1 warning sign for Zhejiang Yasha DecorationLtd that 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.