Zero-debt allows substantial financial flexibility, especially for small-cap companies like K3 Capital Group PLC (LON:K3C), 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.
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Is K3C 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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. The lack of debt on K3C’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 K3C is a high-growth company. K3C delivered a strikingly high revenue growth of 52% over the past year. 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.
Does K3C’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, K3 Capital Group 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. With current liabilities at UK£3.9m, the company has been able to meet these commitments with a current assets level of UK£8.1m, leading to a 2.09x current account ratio. For Professional Services companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Next Steps:
Having no debt on the books means K3C has more financial freedom to keep growing at its current fast rate. 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, its financial position may change. I admit this is a fairly basic analysis for K3C’s financial health. Other important fundamentals need to be considered alongside. You should continue to research K3 Capital Group to get a more holistic view of the stock by looking at: