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.' 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 Foryou Corporation (SZSE:002906) does have debt on its balance sheet. 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 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Foryou's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Foryou had CN¥66.3m of debt in March 2024, down from CN¥173.6m, one year before. But on the other hand it also has CN¥1.51b in cash, leading to a CN¥1.44b net cash position.

How Healthy Is Foryou's Balance Sheet?

We can see from the most recent balance sheet that Foryou had liabilities of CN¥3.37b falling due within a year, and liabilities of CN¥282.8m due beyond that. On the other hand, it had cash of CN¥1.51b and CN¥3.83b worth of receivables due within a year. So it can boast CN¥1.67b more liquid assets than total liabilities.

This short term liquidity is a sign that Foryou could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Foryou has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Foryou grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. 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 Foryou 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Foryou 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 three years, Foryou recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Foryou has net cash of CN¥1.44b, as well as more liquid assets than liabilities. And we liked the look of last year's 64% year-on-year EBIT growth. So we don't think Foryou's use of debt is risky. 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. We've identified 2 warning signs with Foryou , 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.