Zero-debt allows substantial financial flexibility,how to get rid of milfoil especially for small-cap companies like Perfectech International Holdings Limited (

HKG:765

), 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 take you through a few basic checks to assess the financial health of companies with no debt.

Check out our latest analysis for Perfectech International Holdings

Is 765 growing fast enough to value 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. The lack of debt on 765’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 765 is a high-growth company. Opposite to the high growth we were expecting, 765’s negative revenue growth of -36% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.

SEHK:765 Historical Debt, March 1st 2019

Does 765’s liquid assets cover its short-term commitments?

Given zero long-term debt on its balance sheet, Perfectech International Holdings 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. At the current liabilities level of HK$33m, the company has been able to meet these obligations given the level of current assets of HK$125m, with a current ratio of 3.8x. Having said that, a ratio greater than 3x may be considered high by some.

Next Steps:

Having no debt on the books means 765 has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around 765’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, 765’s financial situation may change. This is only a rough assessment of financial health, and I’m sure 765 has company-specific issues impacting its capital structure decisions. I recommend you continue to research Perfectech International Holdings to get a better picture of the stock by looking at:

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Historical Performance

: What has 765’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.

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. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

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