Bannerman Resources Limited (ASX:BMN), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is BMN will have to follow strict debt obligations which will reduce its financial flexibility. While BMN has no debt on its balance sheet, it doesn’t necessarily mean it exhibits 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 BMN growing fast enough to value financial flexibility over lower cost of capital?

Debt capital generally has lower cost of capital compared to equity funding. 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. BMN’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. BMN delivered a negative revenue growth of -67%. 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 BMN pay its short-term liabilities?

Since Bannerman Resources 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. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. At the current liabilities level of AU$310k liabilities, it seems that the business has been able to meet these obligations given the level of current assets of AU$8m, with a current ratio of 27.39x. However, anything above 3x may be considered excessive by some investors.

Next Steps:

As a high-growth company, it may be beneficial for BMN to have some financial flexibility, hence zero-debt. Since there is also no concerns around BMN’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure BMN has company-specific issues impacting its capital structure decisions. I suggest you continue to research Bannerman Resources to get a more holistic view of the stock by looking at: