The direct benefit for RHC Capital Corporation (TSXV:RHC), 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 RHC will have to adhere to stricter debt covenants and have less financial flexibility. 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. Check out our latest analysis for RHC Capital
Does RHC’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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either RHC 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.
Can RHC pay its short-term liabilities?
Since RHC Capital 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 $0.3M liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 7.47x. Though, anything above 3x is considered high and could mean that RHC has too much idle capital in low-earning investments.
Are you a shareholder? Having no debt on the books means RHC 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 suggest researching market expectations for RHC’s future growth.
Are you a potential investor? RHC’s high growth makes financial flexibility an attractive option. Furthermore, its high liquidity ensures the company will continue to operate smoothly should unfavourable circumstances arise. In order to build your confidence in the stock, you need to further examine RHC’s track record. You should continue your analysis by taking a look at RHC’s past performance to figure out RHC’s financial health position.