The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 can see that Electronic Arts Inc. (NASDAQ:EA) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Electronic Arts's Net Debt?

As you can see below, Electronic Arts had US$1.88b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has US$2.77b in cash, leading to a US$884.0m net cash position.

A Look At Electronic Arts' Liabilities

According to the last reported balance sheet, Electronic Arts had liabilities of US$2.47b due within 12 months, and liabilities of US$2.84b due beyond 12 months. Offsetting these obligations, it had cash of US$2.77b as well as receivables valued at US$433.0m due within 12 months. So its liabilities total US$2.11b more than the combination of its cash and short-term receivables.

Since publicly traded Electronic Arts shares are worth a very impressive total of US$37.7b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Electronic Arts also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Electronic Arts saw its EBIT drop by 9.6% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Electronic Arts's ability to maintain a healthy balance sheet going forward. 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. Electronic Arts may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Electronic Arts actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Electronic Arts has US$884.0m in net cash. The cherry on top was that in converted 123% of that EBIT to free cash flow, bringing in US$1.9b. So we don't think Electronic Arts's use of debt is risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Electronic Arts insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.