In any company, including Velpic Limited (ASX:VPC) which has zero-debt on its balance sheet, there are well known benefits of including debt in the capital structure, primarily a lower cost of capital — due to debtholders’ higher claim on assets in the event of liquidation and tax benefits to the company on interest payments.
A drop in the cost of capital beefs up a company’s valuation as the same is used to discount its future cash flows to arrive at the intrinsic value — an estimate of its worth right now. This is one of the reasons – given interest rates at record lows – that most companies tremendously raised debt in their capital structure over the past few years.
On the other hand, rate hikes are imminent, it’s a part of the broader economic cycle. No-debt companies will clearly be in a stronger cash position compared to companies of which most, if not all, will be forced to retire a chunk of their debt due to rising costs. Higher the interest rates, higher the cost of debt. Although zero-debt makes Velpic’s financial strength analysis lot more stressful, there are other metrics to check its financial health. These are a few basic checks to assess the financial health of companies with no debt. View our latest analysis for Velpic
Is Velpic right in choosing financial flexibility instead of a lower cost of capital?
Zero-debt allows substantial financial flexibility, especially for small-cap companies like VPC with its market cap of USD $6 Million as they have limited capability of raising large sums through capital markets. However, choosing financial flexibility over capital returns is logical only if it’s a high-growth company. VPC’s revenue grew 3915.38% over the past year, so it’s acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Does VPC’s cash and short-term assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Velpic has no solvency issues. Solvency is 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, which are mostly comprised of payments to suppliers, bank loans and debts due over the next twelve months. To cover them, a company must have more liquid assets than these obligations. In VPC’s case, its short-term assets of $3 Million exceed the short-term liabilities of $1 Million, indicating sound liquidity position.
Velpic is a fast growing company with a revenue growth of 3915.38% over the past year, making financial flexibility a valuable option for the company. In addition, its current assets cover current liabilities, giving it enough liquidity to operate smoothly in the short-term. Now I recommend you check out our latest free analysis report to see what are VPC’s growth prospects and whether it could be considered an undervalued opportunity.
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