David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that General Mills, Inc. (NYSE:GIS) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for General Mills

What Is General Mills's Net Debt?

The image below, which you can click on for greater detail, shows that at August 2023 General Mills had debt of US$12.3b, up from US$11.6b in one year. However, it does have US$490.9m in cash offsetting this, leading to net debt of about US$11.8b.

A Look At General Mills' Liabilities

We can see from the most recent balance sheet that General Mills had liabilities of US$7.07b falling due within a year, and liabilities of US$13.7b due beyond that. Offsetting this, it had US$490.9m in cash and US$1.79b in receivables that were due within 12 months. So its liabilities total US$18.5b more than the combination of its cash and short-term receivables.

General Mills has a very large market capitalization of US$36.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

General Mills has net debt to EBITDA of 3.0 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 8.3 suggests it can easily service that debt. We saw General Mills grow its EBIT by 6.6% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 General Mills'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, General Mills produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Both General Mills's ability to to convert EBIT to free cash flow and its interest cover gave us comfort that it can handle its debt. Having said that, its net debt to EBITDA somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that General Mills is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for General Mills that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.