Simulations Plus Inc (NASDAQ:SLP), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is SLP will have to follow strict debt obligations which will reduce its financial flexibility. While SLP has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status. See our latest analysis for Simulations Plus
Is financial flexibility worth the lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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. SLP’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. A double-digit revenue growth of 20.86% is considered relatively high for a small-cap company like SLP. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Can SLP meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Simulations Plus has no solvency issues, which is 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. At the current liabilities level of $2.0M liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 6.2x. However, anything about 3x may be excessive, since SLP may be leaving too much capital in low-earning investments.
Next Steps:
Are you a shareholder? SLP 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. Going forward, its financial position may change. I suggest keeping on top of market expectations for SLP’s future growth.