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 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 Vipshop Holdings Limited (NYSE:VIPS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Vipshop Holdings

What Is Vipshop Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Vipshop Holdings had debt of CN¥1.93b, up from CN¥122.4m in one year. But it also has CN¥18.7b in cash to offset that, meaning it has CN¥16.7b net cash.

How Strong Is Vipshop Holdings' Balance Sheet?

According to the last reported balance sheet, Vipshop Holdings had liabilities of CN¥21.1b due within 12 months, and liabilities of CN¥2.16b due beyond 12 months. Offsetting these obligations, it had cash of CN¥18.7b as well as receivables valued at CN¥3.58b due within 12 months. So it has liabilities totalling CN¥994.2m more than its cash and near-term receivables, combined.

Of course, Vipshop Holdings has a market capitalization of CN¥37.9b, 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. While it does have liabilities worth noting, Vipshop Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Vipshop Holdings has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 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.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. Happily for any shareholders, Vipshop Holdings actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

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¥16.7b. The cherry on top was that in converted 113% of that EBIT to free cash flow, bringing in CN¥3.2b. So we are not troubled with Vipshop Holdings's debt use. 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. To that end, you should be aware of the 2 warning signs we've spotted with Vipshop Holdings .

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.