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The direct benefit for Xiwang Property Holdings Company Limited (HKG:2088), 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 2088 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.
Is financial flexibility worth the lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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. The lack of debt on 2088’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if 2088 is a high-growth company. A revenue growth in the teens is not considered high-growth. 2088’s revenue growth of 13% falls into this range. More capital can help the business grow faster. If 2088 is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can 2088 meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Xiwang Property Holdings 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. With current liabilities at CN¥162m, it seems that the business has been able to meet these commitments with a current assets level of CN¥698m, leading to a 4.32x current account ratio. However, many consider a ratio above 3x to be high, although this is not necessarily a bad thing.
2088 is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, 2088’s financial situation may change. This is only a rough assessment of financial health, and I’m sure 2088 has company-specific issues impacting its capital structure decisions. I suggest you continue to research Xiwang Property Holdings to get a more holistic view of the stock by looking at:
- Historical Performance: What has 2088’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.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.