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The direct benefit for 8common Limited (ASX:8CO), 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 8CO will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean 8CO has outstanding financial strength. 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.
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Is 8CO growing fast enough to value financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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. 8CO’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. 8CO’s revenue growth over the past year is a double-digit 24% which is considerably high for a small-cap company. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Can 8CO meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, 8common 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$1.3m liabilities, it appears that the company has been able to meet these commitments with a current assets level of AU$4.1m, leading to a 3.06x current account ratio. However, many consider anything above 3x to be quite high.
Next Steps:
8CO 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 8CO’s liquidity needs, this may be its optimal capital structure for the time being. In the future, 8CO’s financial situation may change. I admit this is a fairly basic analysis for 8CO’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research 8common to get a better picture of the stock by looking at: