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The direct benefit for Immuron Limited (ASX:IMC), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is IMC will have to adhere to stricter debt covenants and have less financial flexibility. 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 recommend you look at the following hurdles to assess IMC’s financial health.
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Is IMC right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. IMC’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. IMC’s revenue growth over the past year is a double-digit 32% which is considerably high for a small-cap company. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Can IMC pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Immuron 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. With current liabilities at AU$803k, it appears that the company has been able to meet these obligations given the level of current assets of AU$7.1m, with a current ratio of 8.78x. Having said that, a ratio greater than 3x may be considered high by some.
Next Steps:
As a high-growth company, it may be beneficial for IMC to have some financial flexibility, hence zero-debt. 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. This is only a rough assessment of financial health, and I’m sure IMC has company-specific issues impacting its capital structure decisions. I suggest you continue to research Immuron to get a better picture of the stock by looking at: