Zero-debt allows substantial financial flexibility, especially for small-cap companies like C4X Discovery Holdings plc (LON:C4XD), 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. 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 go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
Check out our latest analysis for C4X Discovery Holdings
Is financial flexibility worth the 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. The lack of debt on C4XD’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 C4XD is a high-growth company. Opposite to the high growth we were expecting, C4XD’s negative revenue growth of -66% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can C4XD meet its short-term obligations with the cash in hand?
Since C4X Discovery 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. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. Looking at C4XD’s UK£705k in current liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 6.33x. Having said that, a ratio above 3x may be considered excessive by some investors.
Next Steps:
As a high-growth company, it may be beneficial for C4XD 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, its financial position may be different. Keep in mind I haven’t considered other factors such as how C4XD has been performing in the past. I recommend you continue to research C4X Discovery Holdings to get a more holistic view of the stock by looking at: