Is Electronic Arts (NASDAQ:EA) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. 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?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Electronic Arts

How Much Debt Does Electronic Arts Carry?

As you can see below, Electronic Arts had US$1.88b of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. But it also has US$2.42b in cash to offset that, meaning it has US$538.0m net cash.

How Healthy Is Electronic Arts' Balance Sheet?

The latest balance sheet data shows that Electronic Arts had liabilities of US$2.83b due within a year, and liabilities of US$2.72b falling due after that. On the other hand, it had cash of US$2.42b and US$579.0m worth of receivables due within a year. So it has liabilities totalling US$2.56b more than its cash and near-term receivables, combined.

Of course, Electronic Arts has a titanic market capitalization of US$36.5b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Electronic Arts boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Electronic Arts has boosted its EBIT by 43%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Electronic Arts 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Electronic Arts has US$538.0m in net cash. And it impressed us with free cash flow of US$1.8b, being 133% of its EBIT. So is Electronic Arts's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Electronic Arts, you may well want to click here to check an interactive graph of its earnings per share history.

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.