These 4 Measures Indicate That Proya CosmeticsLtd (SHSE:603605) Is Using Debt Safely

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Proya Cosmetics Co.,Ltd. (SHSE:603605) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Proya CosmeticsLtd

How Much Debt Does Proya CosmeticsLtd Carry?

You can click the graphic below for the historical numbers, but it shows that Proya CosmeticsLtd had CN¥878.9m of debt in September 2024, down from CN¥949.1m, one year before. But on the other hand it also has CN¥3.63b in cash, leading to a CN¥2.75b net cash position.

A Look At Proya CosmeticsLtd's Liabilities

We can see from the most recent balance sheet that Proya CosmeticsLtd had liabilities of CN¥1.76b falling due within a year, and liabilities of CN¥804.4m due beyond that. Offsetting these obligations, it had cash of CN¥3.63b as well as receivables valued at CN¥330.1m due within 12 months. So it actually has CN¥1.40b 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.

And we also note warmly that Proya CosmeticsLtd grew its EBIT by 14% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Proya CosmeticsLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Proya CosmeticsLtd has CN¥2.75b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥888m, being 70% of its EBIT. So we don't think Proya CosmeticsLtd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. 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 Proya CosmeticsLtd .

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.