Zero-debt allows substantial financial flexibility, especially for small-cap companies like Venture Minerals Limited (ASX:VMS), 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 VMS has outstanding financial strength. I recommend you look at the following hurdles to assess VMS’s financial health.
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Does VMS’s growth rate justify its decision for financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. Either VMS does not have access to cheap capital, or it may believe this trade-off is not worth it. This makes sense only if the company has a competitive edge and is growing fast off its equity capital. VMS delivered a negative revenue growth of -84%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does VMS’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Venture Minerals has no solvency issues, which is used to describe the company’s ability to meet its long-term obligations. However, another measure of financial health is its short-term obligations, which is known as liquidity. These include payments to suppliers, employees and other stakeholders. At the current liabilities level of AU$988k liabilities, it seems that the business has been able to meet these commitments with a current assets level of AU$2m, leading to a 2.46x current account ratio. Generally, for Metals and Mining companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Next Steps:
VMS 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. In the future, its financial position may change. Keep in mind I haven’t considered other factors such as how VMS has been performing in the past. I recommend you continue to research Venture Minerals to get a better picture of the stock by looking at: