The direct benefit for BMG Resources Limited (ASX:BMG), 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 BMG will have to adhere to stricter debt covenants and have less financial flexibility. While BMG 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.
Is BMG growing fast enough to value 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 BMG’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 BMG is a high-growth company. BMG delivered a strikingly high revenue growth of 89% over the past year. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Does BMG’s liquid assets cover its short-term commitments?
Since BMG Resources 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. Looking at BMG’s AU$18k in current liabilities, it seems that the business has been able to meet these commitments with a current assets level of AU$1.1m, leading to a 62.09x current account ratio. However, a ratio greater than 3x may be considered high by some.
As a high-growth company, it may be beneficial for BMG to have some financial flexibility, hence zero-debt. 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, its financial position may be different. Keep in mind I haven’t considered other factors such as how BMG has been performing in the past. You should continue to research BMG Resources to get a better picture of the stock by looking at:
- Historical Performance: What has BMG’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.
- 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 email@example.com.