Zero-debt allows substantial financial flexibility, especially for small-cap companies like Riedel Resources Limited (ASX:RIE), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean RIE has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. See our latest analysis for Riedel Resources

Is financial flexibility worth the 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 RIE’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 RIE is a high-growth company. RIE delivered a negative revenue growth of -16.17%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.

Does RIE’s liquid assets cover its short-term commitments?

Given zero long-term debt on its balance sheet, Riedel 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. Looking at RIE’s most recent A$0.0M liabilities, it appears that the company has been able to meet these obligations given the level of current assets of A$0.9M, with a current ratio of 27.27x. Though, anything about 3x may be excessive, since RIE may be leaving too much capital in low-earning investments.

Next Steps:

Given that Riedel Resources is a relatively low-growth company, being in a zero-debt position isn’t always optimal. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and whether the company needs financial flexibility at this point in time. Keep in mind I haven’t considered other factors such as how RIE has been performing in the past. I recommend you continue to research Riedel Resources to get a better picture of the stock by looking at: