The direct benefit for Titon Holdings plc (LSE:TON), 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 TON will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean TON has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. View our latest analysis for Titon Holdings
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. Either TON 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. TON’s revenue growth in the teens of 18.09% is not considered as high-growth, especially for a small-cap company. More capital can help the business grow faster. If TON is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Does TON’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Titon Holdings 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. Looking at TON’s most recent £4.7M liabilities, it seems that the business has been able to meet these obligations given the level of current assets of £14.7M, with a current ratio of 3.13x. Though, anything above 3x is considered high and could mean that TON has too much idle capital in low-earning investments.
Next Steps:
Are you a shareholder? As TON’s revenues are not growing at a fast enough pace, having no debt on its balance sheet isn’t necessarily the best thing. As shareholders, you should try and determine whether this strategy is justified for TON, and why financial flexibility is needed at this stage in its business cycle. I suggest you take a look into a future growth analysis to account for what the market expects for the company moving forward.