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.' 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. Importantly, Proya Cosmetics Co.,Ltd. (SHSE:603605) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.

What Is Proya CosmeticsLtd's Debt?

As you can see below, Proya CosmeticsLtd had CN¥953.0m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥3.52b in cash offsetting this, leading to net cash of CN¥2.57b.

How Strong Is Proya CosmeticsLtd's Balance Sheet?

The latest balance sheet data shows that Proya CosmeticsLtd had liabilities of CN¥2.10b due within a year, and liabilities of CN¥798.4m falling due after that. Offsetting this, it had CN¥3.52b in cash and CN¥213.1m in receivables that were due within 12 months. So it actually has CN¥838.3m more liquid assets than total liabilities.

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

In addition to that, we're happy to report that Proya CosmeticsLtd has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. 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 Proya CosmeticsLtd 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 company can only pay off debt with cold hard cash, not accounting profits. While Proya CosmeticsLtd 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 most recent three years, Proya CosmeticsLtd recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Proya CosmeticsLtd has CN¥2.57b in net cash and a decent-looking balance sheet. And we liked the look of last year's 39% year-on-year EBIT growth. So is Proya CosmeticsLtd's debt a risk? It doesn't seem so to us. 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. For example - Proya CosmeticsLtd has 1 warning sign we think 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.