Zero-debt allows substantial financial flexibility, especially for small-cap companies like Acacia Coal Limited (ASX:AJC), as the company does not have to adhere to strict debt covenants. However, it also faces higher cost of capital given interest cost is generally lower than equity. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean AJC has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. Check out our latest analysis for Acacia Coal
Is financial flexibility worth the lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. The lack of debt on AJC’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if AJC is a high-growth company. A single-digit revenue growth of 1.94% for AJC is considerably low for a small-cap company. More capital can help the business grow faster. If AJC is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can AJC meet its short-term obligations with the cash in hand?
Since Acacia Coal doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term used to describe the company’s ability to meet its long-term obligations. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. With current liabilities at A$0.3M liabilities, it appears that the company has been able to meet these obligations given the level of current assets of A$1.8M, with a current ratio of 6.56x. Though, a ratio greater than 3x may be considered as too high, as AJC could be holding too much capital in a low-return investment environment.
Next Steps:
Are you a shareholder? Given that Acacia Coal is a relatively low-growth company, having no debt on its balance sheet isn’t necessarily the best thing. As shareholders, you should try and determine whether this strategy is justified for AJC, and whether the company needs financial flexibility at this point in time. You should take a look into a future growth analysis to properly assess what the market expects for the company moving forward.