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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. 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 Dangerous?

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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Foryou's Debt?

The image below, which you can click on for greater detail, shows that Foryou had debt of CN¥77.1m at the end of June 2024, a reduction from CN¥217.3m over a year. However, it does have CN¥1.31b in cash offsetting this, leading to net cash of CN¥1.23b.

How Strong Is Foryou's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Foryou had liabilities of CN¥3.65b due within 12 months and liabilities of CN¥285.8m due beyond that. On the other hand, it had cash of CN¥1.31b and CN¥3.99b worth of receivables due within a year. So it actually has CN¥1.37b 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. Succinctly put, Foryou boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Foryou grew its EBIT by 99% 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 it is future earnings, more than anything, that will determine Foryou's ability to maintain a healthy balance sheet going forward. 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. Foryou 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. Over the last three years, Foryou barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Foryou has net cash of CN¥1.23b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 99% over the last year. So is Foryou's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Foryou (1 is a bit concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.