The direct benefit for VPCL Limited (ASX:VPC), 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 VPC will have to adhere to stricter debt covenants and have less financial flexibility. While VPC 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.
View our latest analysis for VPCL
Does VPC’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. VPC’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. A revenue growth in the teens is not considered high-growth. VPC’s revenue growth of 12% falls into this range. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Does VPC’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, VPCL 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$996k liabilities, it seems that the business has been able to meet these commitments with a current assets level of AU$2m, leading to a 2.43x current account ratio. Generally, for Software 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:
VPC is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around VPC’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. I admit this is a fairly basic analysis for VPC’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research VPCL to get a more holistic view of the stock by looking at: