Zero-debt allows substantial financial flexibility, especially for small-cap companies like Ramelius Resources Limited (ASX:RMS), 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.

View our latest analysis for Ramelius Resources

Is RMS right in choosing financial flexibility over lower cost of capital?

Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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. Either RMS does not have access to cheap capital, or it may believe this trade-off is not worth it. This makes sense only if the company has a competitive edge and is growing fast off its equity capital. RMS delivered a strikingly high revenue growth of 61% over the past year. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.

Can RMS meet its short-term obligations with the cash in hand?

Given zero long-term debt on its balance sheet, Ramelius Resources 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. At the current liabilities level of AU$40m, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 3.41x. However, a ratio above 3x may be considered excessive by some investors, yet this is not usually a major negative for a company.

Next Steps:

Having no debt on the books means RMS has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around RMS’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. I admit this is a fairly basic analysis for RMS’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Ramelius Resources to get a better picture of the stock by looking at: