Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Foryou Corporation (SZSE:002906) makes use of debt. But the real question is whether this debt is making the company risky.
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Foryou Carry?
The image below, which you can click on for greater detail, shows that Foryou had debt of CN¥62.7m at the end of September 2024, a reduction from CN¥186.4m over a year. But on the other hand it also has CN¥1.35b in cash, leading to a CN¥1.29b net cash position.
How Healthy Is Foryou's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Foryou had liabilities of CN¥4.50b due within 12 months and liabilities of CN¥407.4m due beyond that. On the other hand, it had cash of CN¥1.35b and CN¥4.67b worth of receivables due within a year. So it actually has CN¥1.11b more liquid assets than total liabilities.
This short term liquidity is a sign that Foryou could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Foryou has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Foryou grew its EBIT by 89% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Foryou can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Foryou 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, Foryou recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Summing Up
While it is always sensible to investigate a company's debt, in this case Foryou has CN¥1.29b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 89% over the last year. So we don't have any problem with Foryou's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Foryou .
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.
