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 MillerKnoll, Inc. (NASDAQ:MLKN) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does MillerKnoll Carry?

As you can see below, MillerKnoll had US$1.34b of debt at June 2024, down from US$1.40b a year prior. However, it does have US$230.4m in cash offsetting this, leading to net debt of about US$1.10b.

How Strong Is MillerKnoll's Balance Sheet?

According to the last reported balance sheet, MillerKnoll had liabilities of US$697.7m due within 12 months, and liabilities of US$1.89b due beyond 12 months. Offsetting these obligations, it had cash of US$230.4m as well as receivables valued at US$330.5m due within 12 months. So it has liabilities totalling US$2.02b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's US$1.97b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

MillerKnoll's debt is 2.8 times its EBITDA, and its EBIT cover its interest expense 6.0 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. If MillerKnoll can keep growing EBIT at last year's rate of 10% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if MillerKnoll can strengthen its balance sheet over time. 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. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, MillerKnoll's free cash flow amounted to 46% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

MillerKnoll's struggle to handle its total liabilities had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability to to grow its EBIT isn't too shabby at all. When we consider all the factors discussed, it seems to us that MillerKnoll is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. We've identified 3 warning signs with MillerKnoll , and understanding them should be part of your investment process.

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.