The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Cohu, Inc. (NASDAQ:COHU) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Cohu's Net Debt?

The image below, which you can click on for greater detail, shows that Cohu had debt of US$10.8m at the end of March 2024, a reduction from US$44.1m over a year. However, it does have US$271.3m in cash offsetting this, leading to net cash of US$260.5m.

How Strong Is Cohu's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cohu had liabilities of US$91.1m due within 12 months and liabilities of US$68.0m due beyond that. On the other hand, it had cash of US$271.3m and US$116.0m worth of receivables due within a year. So it can boast US$228.2m more liquid assets than total liabilities.

This surplus suggests that Cohu has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Cohu boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Cohu's load is not too heavy, because its EBIT was down 93% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Cohu'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 company can only pay off debt with cold hard cash, not accounting profits. Cohu 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 three years, Cohu recorded free cash flow worth a fulsome 100% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Cohu has US$260.5m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 100% of that EBIT to free cash flow, bringing in US$57m. So we are not troubled with Cohu's debt use. 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 Cohu that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com