Six Sigma Metals Limited (ASX:SI6), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is SI6 will have to follow strict debt obligations which will reduce its financial flexibility. 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 take you through a few basic checks to assess the financial health of companies with no debt. Check out our latest analysis for Six Sigma Metals

Is SI6 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. The lack of debt on SI6’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 SI6 is a high-growth company. A double-digit revenue growth of 26.38% is considered relatively high for a small-cap company like SI6. 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.

Can SI6 meet its short-term obligations with the cash in hand?

Since Six Sigma Metals 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. 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 A$0.5M liabilities, it seems that the business is not able to meet these obligations given the level of current assets of A$0.2M, with a current ratio of 0.45x below the prudent level of 3x.

Next Steps:

Having no debt on the books means SI6 has more financial freedom to keep growing at its current fast rate. However, its lack of liquidity lowers our confidence around meeting short-term commitments. Some level of low-cost debt funding could help address these needs. ] %} Moving forward, SI6’s financial situation may change. Keep in mind I haven’t considered other factors such as how SI6 has been performing in the past. I suggest you continue to research Six Sigma Metals to get a better picture of the stock by looking at: