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Zero-debt allows substantial financial flexibility, especially for small-cap companies like NuCoal Resources Limited (ASX:NCR), 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.
See our latest analysis for NuCoal Resources
Is financial flexibility worth the lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. NCR’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. NCR delivered a negative revenue growth of -66%. 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 NCR pay its short-term liabilities?
Since NuCoal 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. 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 NCR’s most recent AU$62k liabilities, the company has been able to meet these obligations given the level of current assets of AU$5m, with a current ratio of 75.72x. However, anything above 3x may be considered excessive by some investors.
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As a high-growth company, it may be beneficial for NCR 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, NCR’s financial situation may change. This is only a rough assessment of financial health, and I’m sure NCR has company-specific issues impacting its capital structure decisions. I suggest you continue to research NuCoal Resources to get a more holistic view of the stock by looking at: