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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Baker Technology Limited (SGX:BTP), 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 BTP has outstanding 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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Is BTP growing fast enough to value financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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 BTP’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 BTP is a high-growth company. BTP delivered a negative revenue growth of -31.2%. 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.
Can BTP pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Baker Technology 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 S$5.3m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 15.66x. Though, a ratio greater than 3x may be considered as too high, as BTP could be holding too much capital in a low-return investment environment.
Next Steps:
As a high-growth company, it may be beneficial for BTP 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. Moving forward, BTP’s financial situation may change. This is only a rough assessment of financial health, and I’m sure BTP has company-specific issues impacting its capital structure decisions. You should continue to research Baker Technology to get a better picture of the stock by looking at: