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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Science in Sport plc (LON:SIS), 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 SIS right in choosing financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. The lack of debt on SIS’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 SIS is a high-growth company. A double-digit revenue growth of 27.5% is considered relatively high for a small-cap company like SIS. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Does SIS’s liquid assets cover its short-term commitments?
Since Science in Sport doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term used to describe the company’s ability to meet its long-term obligations. However, another measure of financial health is its short-term obligations, which is known as liquidity. These include payments to suppliers, employees and other stakeholders. At the current liabilities level of UK£2.8m liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 7.88x. However, anything about 3x may be excessive, since SIS may be leaving too much capital in low-earning investments.
Next Steps:
Having no debt on the books means SIS 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, SIS’s financial situation may change. Keep in mind I haven’t considered other factors such as how SIS has been performing in the past. I recommend you continue to research Science in Sport to get a better picture of the stock by looking at: