Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Joyoung Co.,Ltd (SZSE:002242) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is JoyoungLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 JoyoungLtd had debt of CN¥31.0m, up from none in one year. But it also has CN¥2.58b in cash to offset that, meaning it has CN¥2.55b net cash.

How Healthy Is JoyoungLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that JoyoungLtd had liabilities of CN¥3.97b due within 12 months and liabilities of CN¥71.6m due beyond that. Offsetting this, it had CN¥2.58b in cash and CN¥1.96b in receivables that were due within 12 months. So it actually has CN¥500.5m more liquid assets than total liabilities.

This surplus suggests that JoyoungLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that JoyoungLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for JoyoungLtd if management cannot prevent a repeat of the 95% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 JoyoungLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While JoyoungLtd 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, JoyoungLtd 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 we empathize with investors who find debt concerning, you should keep in mind that JoyoungLtd has net cash of CN¥2.55b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥707m, being 275% of its EBIT. So we are not troubled with JoyoungLtd's debt use. 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. Case in point: We've spotted 3 warning signs for JoyoungLtd you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.