The direct benefit for Sunbridge Group Limited (ASX:SBB), 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 SBB will have to adhere to stricter debt covenants and have less financial flexibility. While SBB has no debt on its balance sheet, it doesn’t necessarily mean it exhibits 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 Sunbridge Group

Is SBB 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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either SBB does not have access to cheap capital, or it may believe this trade-off is not worth it. This makes sense only if the company has a competitive edge and is growing fast off its equity capital. A revenue growth in the teens is not considered high-growth. SBB’s revenue growth of 18% falls into this range. More capital can help the business grow faster. If SBB is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.

Can SBB pay its short-term liabilities?

Given zero long-term debt on its balance sheet, Sunbridge 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. Looking at SBB’s most recent AU$5m liabilities, it seems that the business has been able to meet these obligations given the level of current assets of AU$58m, with a current ratio of 11.1x. However, many consider anything above 3x to be quite high and could mean that SBB has too much idle capital in low-earning investments.

Next Steps:

As a high-growth company, it may be beneficial for SBB to have some financial flexibility, hence zero-debt. Since there is also no concerns around SBB’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. Keep in mind I haven’t considered other factors such as how SBB has been performing in the past. I recommend you continue to research Sunbridge Group to get a more holistic view of the stock by looking at: