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Zero-debt allows substantial financial flexibility, especially for small-cap companies like AFC Group Holdings Limited (NZSE:AFC), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean AFC has outstanding financial strength. I recommend you look at the following hurdles to assess AFC’s financial health.
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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. 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. The lack of debt on AFC’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 AFC is a high-growth company. AFC delivered a negative revenue growth of -49%. 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 AFC’s liquid assets cover its short-term commitments?
Since AFC Group Holdings 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 AFC’s NZ$787k in current liabilities, it seems that the business has been able to meet these commitments with a current assets level of NZ$3.6m, leading to a 4.56x current account ratio. Having said that, a ratio greater than 3x may be considered high by some.
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As a high-growth company, it may be beneficial for AFC to have some financial flexibility, hence zero-debt. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. In the future, AFC’s financial situation may change. I admit this is a fairly basic analysis for AFC’s financial health. Other important fundamentals need to be considered alongside. You should continue to research AFC Group Holdings to get a better picture of the stock by looking at: