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 Vipshop Holdings Limited (NYSE:VIPS) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Vipshop Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Vipshop Holdings had CN¥5.40b of debt, an increase on CN¥791.2m, over one year. But it also has CN¥23.4b in cash to offset that, meaning it has CN¥18.0b net cash.

How Healthy Is Vipshop Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Vipshop Holdings had liabilities of CN¥27.2b due within 12 months and liabilities of CN¥3.20b due beyond that. Offsetting these obligations, it had cash of CN¥23.4b as well as receivables valued at CN¥4.09b due within 12 months. So it has liabilities totalling CN¥2.84b more than its cash and near-term receivables, combined.

Of course, Vipshop Holdings has a market capitalization of CN¥49.3b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Vipshop Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Vipshop Holdings grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Vipshop Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Vipshop Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Vipshop Holdings produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

We could understand if investors are concerned about Vipshop Holdings's liabilities, but we can be reassured by the fact it has has net cash of CN¥18.0b. And we liked the look of last year's 21% year-on-year EBIT growth. So we don't think Vipshop Holdings's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Vipshop Holdings is showing 1 warning sign in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.