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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Solid State plc (LON:SOLI), 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 SOLI has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
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Is financial flexibility worth the 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. Either SOLI 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. A revenue growth in the teens is not considered high-growth. SOLI’s revenue growth of 15.6% falls into this range. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Can SOLI pay its short-term liabilities?
Since Solid State 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. At the current liabilities level of UK£7.4m liabilities, it appears that the company has been able to meet these obligations given the level of current assets of UK£17.4m, with a current ratio of 2.35x. Generally, for Electronic companies, this is a reasonable ratio since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Next Steps:
SOLI 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. This is only a rough assessment of financial health, and I’m sure SOLI has company-specific issues impacting its capital structure decisions. I suggest you continue to research Solid State to get a more holistic view of the stock by looking at: