The direct benefit for Northamber plc (AIM:NAR), 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 NAR 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 NAR has outstanding financial strength. I recommend you look at the following hurdles to assess NAR’s financial health. Check out our latest analysis for Northamber
Does NAR’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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either NAR 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. NAR delivered a negative revenue growth of -7.37%. 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.
Does NAR’s liquid assets cover its short-term commitments?
Since Northamber 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. Looking at NAR’s most recent £8.2M liabilities, the company has been able to meet these obligations given the level of current assets of £18.2M, with a current ratio of 2.23x. For electronic companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too capital in low return investments.
Are you a shareholder? NAR’s soft top-line growth means not having any low-cost debt funding may not be optimal for the business. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and why financial flexibility is needed at this stage in its business cycle. I recommend taking a look into a future growth analysis to examine the company’s position.
Are you a potential investor? The company’s current holding of liquid assets gives it some level of security in any case of adverse events. However, a relatively low revenue growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. I admit this is a fairly basic analysis for NAR’s financial health. Other important fundamentals need to be considered alongside. For your next step, you should take a look at NAR’s past performance to conclude on NAR’s financial health.