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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Computer Modelling Group Ltd. (TSE:CMG), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean CMG has outstanding financial strength. I recommend you look at the following hurdles to assess CMG’s financial health.
Is financial flexibility worth the 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. CMG’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. Opposite to the high growth we were expecting, CMG’s negative revenue growth of -1.7% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does CMG’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Computer Modelling Group has no solvency issues, which is used to describe the company’s ability to meet its long-term obligations. However, another measure of financial health is its short-term obligations, which is known as liquidity. These include payments to suppliers, employees and other stakeholders. Looking at CMG’s CA$19m in current liabilities, it appears that the company has been able to meet these commitments with a current assets level of CA$55m, leading to a 2.82x current account ratio. Generally, for Energy Services companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
CMG 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 CMG’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, CMG’s financial situation may change. I admit this is a fairly basic analysis for CMG’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Computer Modelling Group to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for CMG’s future growth? Take a look at our free research report of analyst consensus for CMG’s outlook.
- Valuation: What is CMG 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 CMG 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.