Zero-debt allows substantial financial flexibility, especially for small-cap companies like Cradle Resources Limited (ASX:CXX), 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. While zero-debt makes the due diligence for potential investors less nerve-racking, it poses a new question: how should they assess the financial strength of such companies? I will take you through a few basic checks to assess the financial health of companies with no debt. View our latest analysis for Cradle Resources
Is CXX growing fast enough to value financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. The lack of debt on CXX’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 CXX is a high-growth company.
Can CXX meet its short-term obligations with the cash in hand?
Since Cradle Resources 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$0.5M liabilities, the company has been able to meet these commitments with a current assets level of A$1.5M, leading to a 3.09x current account ratio. However, anything about 3x may be excessive, since CXX may be leaving too much capital in low-earning investments.
Next Steps:
Are you a shareholder? CXX is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, its financial position may be different. You should always be researching market expectations for CXX’s future growth.
Are you a potential investor? Cradle Resources is a fast-growing company, making financial flexibility a valuable option for the company. Moreover, its high liquidity means the company should continue to operate smoothly in the case of adverse events. In order to build your conviction in the stock, you need to also examine the company’s track record. You should continue your analysis by taking a look at CXX’s past performance to figure out CXX’s financial health position.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.