The direct benefit for Rimfire Pacific Mining NL (ASX:RIM), 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 RIM will have to adhere to stricter debt covenants and have less financial flexibility. While RIM 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 RIM’s financial health.

See our latest analysis for Rimfire Pacific Mining

Is RIM right in choosing 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. RIM’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. RIM delivered a negative revenue growth of -18%. 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 RIM’s liquid assets cover its short-term commitments?

Given zero long-term debt on its balance sheet, Rimfire Pacific Mining 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 RIM’s AU$270k in current liabilities, it seems that the business has been able to meet these obligations given the level of current assets of AU$948k, with a current ratio of 3.51x. However, a ratio greater than 3x may be considered high by some.

Next Steps:

Having no debt on the books means RIM has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around RIM’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 RIM’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Rimfire Pacific Mining to get a more holistic view of the stock by looking at:

1. Historical Performance: What has RIM’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.

2. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.