The direct benefit for Perfect Shape Beauty Technology Limited (SEHK:1830), 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 1830 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 1830 has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. Check out our latest analysis for Perfect Shape Beauty Technology
Does 1830’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either 1830 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. 1830 delivered a negative revenue growth of -13.89%. 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.
Can 1830 pay its short-term liabilities?
Since Perfect Shape Beauty Technology 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. 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 1830’s most recent HK$259.2M liabilities, the company has been able to meet these obligations given the level of current assets of HK$458.3M, with a current ratio of 1.77x. For consumer services companies, this ratio is within a sensible range since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Next Steps:
Are you a shareholder? As 1830’s revenues are not growing at a fast enough pace, not having any low-cost debt funding may not be optimal for the business. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and why financial flexibility is needed at this stage in its business cycle. I recommend taking a look into a future growth analysis to properly assess what the market expects for the company moving forward.