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.' 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 37 Interactive Entertainment Network Technology Group Co., Ltd. (SZSE:002555) 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is 37 Interactive Entertainment Network Technology Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 37 Interactive Entertainment Network Technology Group had CN¥2.23b of debt, an increase on CN¥2.04b, over one year. However, it does have CN¥7.46b in cash offsetting this, leading to net cash of CN¥5.23b.

A Look At 37 Interactive Entertainment Network Technology Group's Liabilities

According to the last reported balance sheet, 37 Interactive Entertainment Network Technology Group had liabilities of CN¥6.63b due within 12 months, and liabilities of CN¥107.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥7.46b as well as receivables valued at CN¥1.28b due within 12 months. So it actually has CN¥2.00b more liquid assets than total liabilities.

This short term liquidity is a sign that 37 Interactive Entertainment Network Technology Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that 37 Interactive Entertainment Network Technology Group has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that 37 Interactive Entertainment Network Technology Group has seen its EBIT plunge 16% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 37 Interactive Entertainment Network Technology Group'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. 37 Interactive Entertainment Network Technology Group 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, 37 Interactive Entertainment Network Technology Group recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case 37 Interactive Entertainment Network Technology Group has CN¥5.23b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in CN¥1.2b. So is 37 Interactive Entertainment Network Technology Group's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for 37 Interactive Entertainment Network Technology Group that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.