Coffee Holding (NASDAQ:JVA) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Coffee Holding Co., Inc. (NASDAQ:JVA) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Coffee Holding

What Is Coffee Holding's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Coffee Holding had US$1.90m of debt in July 2024, down from US$9.03m, one year before. However, it does have US$3.10m in cash offsetting this, leading to net cash of US$1.20m.

How Healthy Is Coffee Holding's Balance Sheet?

According to the last reported balance sheet, Coffee Holding had liabilities of US$7.35m due within 12 months, and liabilities of US$1.03m due beyond 12 months. On the other hand, it had cash of US$3.10m and US$7.45m worth of receivables due within a year. So it can boast US$2.17m more liquid assets than total liabilities.

This short term liquidity is a sign that Coffee Holding could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Coffee Holding has more cash than debt is arguably a good indication that it can manage its debt safely.

We also note that Coffee Holding improved its EBIT from a last year's loss to a positive US$1.5m. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Coffee Holding will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Coffee Holding may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Coffee Holding actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Coffee Holding has net cash of US$1.20m, as well as more liquid assets than liabilities. The cherry on top was that in converted 305% of that EBIT to free cash flow, bringing in US$4.7m. So is Coffee Holding's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Coffee Holding (at least 2 which can't be ignored) , 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.