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.' 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. As with many other companies Lulu's Fashion Lounge Holdings, Inc. (NASDAQ:LVLU) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Lulu's Fashion Lounge Holdings Carry?

The image below, which you can click on for greater detail, shows that at December 2024 Lulu's Fashion Lounge Holdings had debt of US$13.1m, up from US$8.00m in one year. On the flip side, it has US$4.46m in cash leading to net debt of about US$8.63m.

How Healthy Is Lulu's Fashion Lounge Holdings' Balance Sheet?

We can see from the most recent balance sheet that Lulu's Fashion Lounge Holdings had liabilities of US$74.3m falling due within a year, and liabilities of US$20.5m due beyond that. Offsetting this, it had US$4.46m in cash and US$6.34m in receivables that were due within 12 months. So it has liabilities totalling US$84.0m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the US$16.6m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Lulu's Fashion Lounge Holdings would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Lulu's Fashion Lounge Holdings 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.

In the last year Lulu's Fashion Lounge Holdings had a loss before interest and tax, and actually shrunk its revenue by 11%, to US$316m. We would much prefer see growth.

Caveat Emptor

Not only did Lulu's Fashion Lounge Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping US$24m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through US$273k in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Lulu's Fashion Lounge Holdings (1 is concerning) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.