The direct benefit for Sienna Cancer Diagnostics Limited (ASX:SDX), 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 SDX 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 SDX 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 Sienna Cancer Diagnostics
Does SDX’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. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. Either SDX 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. SDX delivered a negative revenue growth of -38.31%. 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 SDX pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Sienna Cancer Diagnostics 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 AU$353.48k liabilities, it appears that the company has been able to meet these obligations given the level of current assets of AU$3.68m, with a current ratio of 10.42x. Though, anything about 3x may be excessive, since SDX may be leaving too much capital in low-earning investments.
Having no debt on the books means SDX has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. In the future, its financial position may change. I admit this is a fairly basic analysis for SDX’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Sienna Cancer Diagnostics to get a better picture of the stock by looking at:
- Historical Performance: What has SDX’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.
- 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.