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Zero-debt allows substantial financial flexibility, especially for small-cap companies like New World Cobalt Limited (ASX:NWC), 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 NWC 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 New World Cobalt
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 NWC 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. NWC’s revenue growth over the past year was an impressively high triple-digit rate, 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 NWC pay its short-term liabilities?
Given zero long-term debt on its balance sheet, New World Cobalt 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 NWC’s AU$360k in current liabilities, it seems that the business has been able to meet these commitments with a current assets level of AU$2.6m, leading to a 7.25x current account ratio. Having said that, many consider a ratio above 3x to be high.
Next Steps:
Having no debt on the books means NWC has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around NWC’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure NWC has company-specific issues impacting its capital structure decisions. You should continue to research New World Cobalt to get a better picture of the stock by looking at:
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Historical Performance: What has NWC’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
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Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.