Electronic Arts (NASDAQ:EA) 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.' 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?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. 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 Electronic Arts

What Is Electronic Arts's Net Debt?

As you can see below, Electronic Arts had US$1.88b 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 US$2.31b in cash offsetting this, leading to net cash of US$424.0m.

How Healthy Is Electronic Arts' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Electronic Arts had liabilities of US$2.79b due within 12 months and liabilities of US$2.78b due beyond that. On the other hand, it had cash of US$2.31b and US$1.05b worth of receivables due within a year. So its liabilities total US$2.21b more than the combination of its cash and short-term receivables.

Given Electronic Arts has a humongous market capitalization of US$37.1b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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.

Fortunately, Electronic Arts grew its EBIT by 9.6% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. Over the last three years, Electronic Arts actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

We could understand if investors are concerned about Electronic Arts's liabilities, but we can be reassured by the fact it has has net cash of US$424.0m. The cherry on top was that in converted 121% of that EBIT to free cash flow, bringing in US$2.0b. So is Electronic Arts's debt a risk? It doesn't seem so to us. 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 Electronic Arts .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.