Zero-debt allows substantial financial flexibility, especially for small-cap companies like Biomerica Inc (NASDAQ:BMRA), 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.
Is financial flexibility worth the lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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 BMRA’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 BMRA is a high-growth company. BMRA delivered a negative revenue growth of -3.9%. 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.
Can BMRA meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Biomerica 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 BMRA’s most recent US$896.8k liabilities, it appears that the company has been able to meet these obligations given the level of current assets of US$4.5m, with a current ratio of 5x. Having said that, a ratio greater than 3x may be considered as quite high, and some might argue BMRA could be holding too much capital in a low-return investment environment.
BMRA is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around BMRA’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may be different. I admit this is a fairly basic analysis for BMRA’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Biomerica to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for BMRA’s future growth? Take a look at our free research report of analyst consensus for BMRA’s outlook.
- Valuation: What is BMRA worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether BMRA is currently mispriced by the market.
- 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 firstname.lastname@example.org.