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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that 37 Interactive Entertainment Network Technology Group Co., Ltd. (SZSE:002555) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for 37 Interactive Entertainment Network Technology Group

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

The image below, which you can click on for greater detail, shows that 37 Interactive Entertainment Network Technology Group had debt of CN¥370.0m at the end of March 2022, a reduction from CN¥474.4m over a year. However, its balance sheet shows it holds CN¥7.06b in cash, so it actually has CN¥6.69b net cash.

How Healthy Is 37 Interactive Entertainment Network Technology Group's Balance Sheet?

According to the last reported balance sheet, 37 Interactive Entertainment Network Technology Group had liabilities of CN¥3.33b due within 12 months, and liabilities of CN¥202.9m due beyond 12 months. Offsetting these obligations, it had cash of CN¥7.06b as well as receivables valued at CN¥1.68b due within 12 months. So it actually has CN¥5.21b 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. Succinctly put, 37 Interactive Entertainment Network Technology Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, 37 Interactive Entertainment Network Technology Group grew its EBIT by 67% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if 37 Interactive Entertainment Network Technology Group 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While 37 Interactive Entertainment Network Technology Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, 37 Interactive Entertainment Network Technology Group generated free cash flow amounting to a very robust 95% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that 37 Interactive Entertainment Network Technology Group has net cash of CN¥6.69b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥3.3b, being 95% of its EBIT. 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. Be aware that 37 Interactive Entertainment Network Technology Group is showing 1 warning sign in our investment analysis , you should know about...

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.