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 Johnson & Johnson (NYSE:JNJ) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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 cant fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Johnson & Johnson

As you can see below, Johnson & Johnson had US$27.7b of debt at December 2019, down from US$29.4b a year prior. However, it does have US$20.0b in cash offsetting this, leading to net debt of about US$7.72b.

The latest balance sheet data shows that Johnson & Johnson had liabilities of US$36.0b due within a year, and liabilities of US$62.3b falling due after that. Offsetting these obligations, it had cash of US$20.0b as well as receivables valued at US$14.5b due within 12 months. So it has liabilities totalling US$63.8b more than its cash and near-term receivables, combined.

Since publicly traded Johnson & Johnson shares are worth a very impressive total of US$400.8b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a companys debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

Johnson & Johnson has a low debt to EBITDA ratio of only 0.27. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So theres no doubt this company can take on debt while staying cool as a cucumber. Fortunately, Johnson & Johnson grew its EBIT by 2.4% in the last year, making that debt load look even more manageable. Theres no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Johnson & Johnsons 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.

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. Over the last three years, Johnson & Johnson recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than wed usually expect. That positions it well to pay down debt if desirable to do so.

Johnson & Johnsons interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14s goalkeeper. And thats just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Zooming out, Johnson & Johnson seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. Theres 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. Consider for instance, the ever-present spectre of investment risk. Weve identified 3 warning signs with Johnson & Johnson , and understanding them should be part of your investment process.

At the end of the day, its 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). Its free.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.

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Is Johnson & Johnson (NYSE:JNJ) A Risky Investment? - Simply Wall St