The direct benefit for BrainChip Holdings Limited (ASX:BRN), 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 BRN will have to adhere to stricter debt covenants and have less financial flexibility. While BRN 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.

Check out our latest analysis for BrainChip Holdings

Is BRN growing fast enough to value financial flexibility over 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. BRN’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. BRN’s revenue growth over the past year was an impressively high triple-digit rate, therefore the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.

Can BRN pay its short-term liabilities?

Given zero long-term debt on its balance sheet, BrainChip Holdings has no solvency issues, which is 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. With current liabilities at US$1.0m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 12.09x. However, many consider anything above 3x to be quite high.

Next Steps:

As a high-growth company, it may be beneficial for BRN 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. Going forward, BRN’s financial situation may change. This is only a rough assessment of financial health, and I’m sure BRN has company-specific issues impacting its capital structure decisions. You should continue to research BrainChip Holdings to get a better picture of the stock by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for BRN’s future growth? Take a look at our free research report of analyst consensus for BRN’s outlook.

2. Valuation: What is BRN worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether BRN is currently mispriced by the market.

3. 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.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.