China Finance Online Co Limited (NASDAQ:JRJC), 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 JRJC 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 recommend you look at the following hurdles to assess JRJC’s financial health. View our latest analysis for China Finance Online
Is JRJC 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. 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. JRJC’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. JRJC delivered a negative revenue growth of -22.67%. 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 JRJC meet its short-term obligations with the cash in hand?
Since China Finance Online 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 JRJC’s most recent $85.1M liabilities, it seems that the business has been able to meet these obligations given the level of current assets of $149.8M, with a current ratio of 1.76x. For internet companies, this ratio is within a sensible range since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Are you a shareholder? JRJC’s soft top-line growth means not having any low-cost debt funding may not be optimal for the business. As shareholders, you should try and determine whether this strategy is justified for JRJC, and whether the company needs financial flexibility at this point in time. You should take a look into a future growth analysis to examine the company’s position.
Are you a potential investor? In terms of meeting is short term obligations, there’s nothing to worry about for JRJC. However, its low sales growth means there’s potential to improve return on capital by taking on some debt and ramp up growth. This is only a rough assessment of financial health, and I’m sure JRJC has company-specific issues impacting its capital structure decisions. For your next step, you should take a look at JRJC’s past performance to conclude on JRJC’s financial health.
To help readers see pass 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.