Reverse Corp Limited (ASX:REF), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is REF will have to follow strict debt obligations which will reduce its financial flexibility. While REF has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
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Does REF’s growth rate justify its decision for financial flexibility over 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 REF 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. A double-digit revenue growth of 34% is considered relatively high for a small-cap company like REF. So, it is 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.
Can REF pay its short-term liabilities?
Since Reverse 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. Looking at REF’s AU$936k in current liabilities, the company has been able to meet these obligations given the level of current assets of AU$6.9m, with a current ratio of 7.4x. However, a ratio above 3x may be considered excessive by some investors.
Having no debt on the books means REF 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. Moving forward, its financial position may be different. I admit this is a fairly basic analysis for REF’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Reverse to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for REF’s future growth? Take a look at our free research report of analyst consensus for REF’s outlook.
- Historical Performance: What has REF’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.
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 email@example.com.