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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Foryou Corporation (SZSE:002906) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Foryou

What Is Foryou's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Foryou had CN¥299.2m of debt, an increase on none, over one year. However, it does have CN¥945.7m in cash offsetting this, leading to net cash of CN¥646.5m.

A Look At Foryou's Liabilities

Zooming in on the latest balance sheet data, we can see that Foryou had liabilities of CN¥2.16b due within 12 months and liabilities of CN¥246.1m due beyond that. Offsetting this, it had CN¥945.7m in cash and CN¥2.18b in receivables that were due within 12 months. So it actually has CN¥714.3m 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 50% 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Looking at the most recent two years, Foryou recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Foryou has net cash of CN¥646.5m, as well as more liquid assets than liabilities. And we liked the look of last year's 50% year-on-year EBIT growth. So is Foryou's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Foryou .

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.