Zero-debt allows substantial financial flexibility, especially for small-cap companies like Bounty Oil & Gas NL (ASX:BUY), 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 BUY has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I recommend you look at the following hurdles to assess BUY’s financial health.

View our latest analysis for Bounty Oil & Gas

Does BUY’s growth rate justify its decision for 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. The lack of debt on BUY’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 BUY is a high-growth company. Opposite to the high growth we were expecting, BUY’s negative revenue growth of -41% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.

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

Given zero long-term debt on its balance sheet, Bounty Oil & Gas 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. Looking at BUY’s most recent AU$2m liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.3x. Generally, for Oil and Gas companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.

Next Steps:

As a high-growth company, it may be beneficial for BUY 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, its financial position may change. I admit this is a fairly basic analysis for BUY’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Bounty Oil & Gas to get a better picture of the stock by looking at: