GungHo Online Entertainment (TSE:3765) Seems To Use Debt Rather Sparingly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, GungHo Online Entertainment, Inc. (TSE:3765) does carry debt. But the more important question is: how much risk is that debt creating?

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 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. 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.

View our latest analysis for GungHo Online Entertainment

What Is GungHo Online Entertainment's Debt?

As you can see below, at the end of December 2024, GungHo Online Entertainment had JP¥1.28b of debt, up from none a year ago. Click the image for more detail. However, it does have JP¥104.6b in cash offsetting this, leading to net cash of JP¥103.3b.

How Healthy Is GungHo Online Entertainment's Balance Sheet?

We can see from the most recent balance sheet that GungHo Online Entertainment had liabilities of JP¥19.5b falling due within a year, and liabilities of JP¥2.48b due beyond that. Offsetting this, it had JP¥104.6b in cash and JP¥13.5b in receivables that were due within 12 months. So it actually has JP¥96.1b more liquid assets than total liabilities.

This surplus strongly suggests that GungHo Online Entertainment has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that GungHo Online Entertainment has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for GungHo Online Entertainment if management cannot prevent a repeat of the 37% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 GungHo Online Entertainment'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. GungHo Online Entertainment 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. Over the most recent three years, GungHo Online Entertainment 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 we empathize with investors who find debt concerning, you should keep in mind that GungHo Online Entertainment has net cash of JP¥103.3b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of JP¥17b, being 75% of its EBIT. So we don't think GungHo Online Entertainment's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for GungHo Online Entertainment you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.