David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Lily Group Co., Ltd. (SHSE:603823) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Lily Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Lily Group had CN¥176.0m of debt in September 2024, down from CN¥194.0m, one year before. However, it does have CN¥583.3m in cash offsetting this, leading to net cash of CN¥407.3m.

How Healthy Is Lily Group's Balance Sheet?

We can see from the most recent balance sheet that Lily Group had liabilities of CN¥782.0m falling due within a year, and liabilities of CN¥112.6m due beyond that. Offsetting these obligations, it had cash of CN¥583.3m as well as receivables valued at CN¥942.0m due within 12 months. So it can boast CN¥630.7m more liquid assets than total liabilities.

This surplus suggests that Lily Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Lily Group has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Lily Group grew its EBIT by 82% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lily Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Lily Group 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. During the last three years, Lily Group produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Lily Group has net cash of CN¥407.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 82% over the last year. So we don't think Lily Group's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Lily Group , and understanding them should be part of your investment process.

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.