Zero-debt allows substantial financial flexibility, especially for small-cap companies like Tamawood Limited (ASX:TWD), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean TWD 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 Tamawood
Is TWD growing fast enough to value financial flexibility over 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 TWD 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 double-digit revenue growth of 20.83% is considered relatively high for a small-cap company like TWD. 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 TWD meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Tamawood 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 A$10.5M liabilities, the company has been able to meet these obligations given the level of current assets of A$25.9M, with a current ratio of 2.47x. Generally, for consumer durables 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:
Are you a shareholder? As a high-growth company, it may be beneficial for TWD to have some financial flexibility, hence zero-debt. Since there is also no concerns around TWD’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, TWD’s financial situation may change. You should always be researching market expectations for TWD’s future growth.