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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that YOOZOO Interactive Co., Ltd. (SZSE:002174) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is YOOZOO Interactive's Net Debt?

As you can see below, YOOZOO Interactive had CN¥992.6m of debt at March 2024, down from CN¥1.05b a year prior. However, it does have CN¥1.61b in cash offsetting this, leading to net cash of CN¥622.2m.

How Healthy Is YOOZOO Interactive's Balance Sheet?

The latest balance sheet data shows that YOOZOO Interactive had liabilities of CN¥751.9m due within a year, and liabilities of CN¥706.6m falling due after that. Offsetting these obligations, it had cash of CN¥1.61b as well as receivables valued at CN¥275.3m due within 12 months. So it actually has CN¥431.6m more liquid assets than total liabilities.

This short term liquidity is a sign that YOOZOO Interactive could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, YOOZOO Interactive boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, YOOZOO Interactive turned things around in the last 12 months, delivering and EBIT of CN¥142m. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine YOOZOO Interactive'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. YOOZOO Interactive 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 year, YOOZOO Interactive saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case YOOZOO Interactive has CN¥622.2m in net cash and a decent-looking balance sheet. So we are not troubled with YOOZOO Interactive's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for YOOZOO Interactive you should be aware of.

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.

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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.