Zero-debt allows substantial financial flexibility, especially for small-cap companies like Weebit Nano Limited (ASX:WBT), 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 zero-debt makes the due diligence for potential investors less nerve-racking, it poses a new question: how should they assess the financial strength of such companies? I will take you through a few basic checks to assess the financial health of companies with no debt. See our latest analysis for Weebit Nano
Is WBT right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either WBT 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. Opposite to the high growth we were expecting, WBT’s negative revenue growth of -98.56% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can WBT meet its short-term obligations with the cash in hand?
Since Weebit Nano 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. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. With current liabilities at AU$508.61k, the company has been able to meet these commitments with a current assets level of AU$3.66m, leading to a 7.2x current account ratio. However, anything about 3x may be excessive, since WBT may be leaving too much capital in low-earning investments.
Having no debt on the books means WBT has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around WBT’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, WBT’s financial situation may change. This is only a rough assessment of financial health, and I’m sure WBT has company-specific issues impacting its capital structure decisions. I suggest you continue to research Weebit Nano to get a better picture of the stock by looking at:
- Historical Performance: What has WBT’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.