These 4 Measures Indicate That Procter & Gamble (NYSE:PG) Is Using Debt Reasonably Well

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.' 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 note that The Procter & Gamble Company (NYSE:PG) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Procter & Gamble

What Is Procter & Gamble's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Procter & Gamble had debt of US$34.6b, up from US$31.5b in one year. On the flip side, it has US$8.25b in cash leading to net debt of about US$26.4b.

A Look At Procter & Gamble's Liabilities

Zooming in on the latest balance sheet data, we can see that Procter & Gamble had liabilities of US$35.8b due within 12 months and liabilities of US$38.0b due beyond that. Offsetting these obligations, it had cash of US$8.25b as well as receivables valued at US$5.47b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$60.0b.

Since publicly traded Procter & Gamble shares are worth a very impressive total of US$362.0b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Procter & Gamble has a low net debt to EBITDA ratio of only 1.2. And its EBIT covers its interest expense a whopping 42.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. While Procter & Gamble doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Procter & Gamble 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 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, Procter & Gamble produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Procter & Gamble's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Taking all this data into account, it seems to us that Procter & Gamble takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Procter & Gamble you should know about.

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.