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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Zbom Home Collection Co.,Ltd (SHSE:603801) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Zbom Home CollectionLtd's Debt?

As you can see below, Zbom Home CollectionLtd had CN¥407.0m of debt at March 2024, down from CN¥556.9m a year prior. But it also has CN¥768.1m in cash to offset that, meaning it has CN¥361.1m net cash.

How Strong Is Zbom Home CollectionLtd's Balance Sheet?

We can see from the most recent balance sheet that Zbom Home CollectionLtd had liabilities of CN¥2.07b falling due within a year, and liabilities of CN¥281.5m due beyond that. Offsetting these obligations, it had cash of CN¥768.1m as well as receivables valued at CN¥1.40b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥181.5m.

Given Zbom Home CollectionLtd has a market capitalization of CN¥4.46b, it's hard to believe these liabilities pose much threat. 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, Zbom Home CollectionLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Zbom Home CollectionLtd saw its EBIT drop by 8.2% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zbom Home CollectionLtd 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, a company can only pay off debt with cold hard cash, not accounting profits. Zbom Home CollectionLtd 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. In the last three years, Zbom Home CollectionLtd's free cash flow amounted to 28% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

We could understand if investors are concerned about Zbom Home CollectionLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥361.1m. So we are not troubled with Zbom Home CollectionLtd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Zbom Home CollectionLtd (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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.