Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies YAPP Automotive Systems Co., Ltd. (SHSE:603013) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is YAPP Automotive Systems's Net Debt?

As you can see below, YAPP Automotive Systems had CN¥84.4m of debt at March 2024, down from CN¥171.8m a year prior. But it also has CN¥2.03b in cash to offset that, meaning it has CN¥1.95b net cash.

How Healthy Is YAPP Automotive Systems' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that YAPP Automotive Systems had liabilities of CN¥2.00b due within 12 months and liabilities of CN¥335.0m due beyond that. Offsetting this, it had CN¥2.03b in cash and CN¥1.65b in receivables that were due within 12 months. So it actually has CN¥1.35b more liquid assets than total liabilities.

This surplus suggests that YAPP Automotive Systems is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that YAPP Automotive Systems has more cash than debt is arguably a good indication that it can manage its debt safely.

While YAPP Automotive Systems doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since YAPP Automotive Systems will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While YAPP Automotive Systems 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, YAPP Automotive Systems actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case YAPP Automotive Systems has CN¥1.95b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 107% of that EBIT to free cash flow, bringing in CN¥914m. So is YAPP Automotive Systems's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for YAPP Automotive Systems that you should be aware of.

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.