Zero-debt allows substantial financial flexibility, especially for small-cap companies like Zhejiang Prospect Company Limited (SEHK:8273), 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. While 8273 has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I recommend you look at the following hurdles to assess 8273’s financial health. Check out our latest analysis for Zhejiang Prospect
Is 8273 growing fast enough to value financial flexibility over 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. 8273’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. Opposite to the high growth we were expecting, 8273’s negative revenue growth of -10.22% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can 8273 meet its short-term obligations with the cash in hand?
Since Zhejiang Prospect 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. With current liabilities at CN¥31.4M liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 3.95x. However, anything above 3x is considered high and could mean that 8273 has too much idle capital in low-earning investments.
Next Steps:
Are you a shareholder? 8273 is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around 8273’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, 8273’s financial situation may change. You should always be keeping on top of market expectations for 8273’s future growth.