Flex Pharma Inc (NASDAQ:FLKS), 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 FLKS will have to follow strict debt obligations which will reduce its financial flexibility. While FLKS 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.
Does FLKS’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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 FLKS’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 FLKS is a high-growth company. FLKS delivered a negative revenue growth of -24%. 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 FLKS pay its short-term liabilities?
Since Flex Pharma 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. 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. At the current liabilities level of US$4m liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 4.46x. Having said that, many consider anything above 3x to be quite high.
FLKS is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, its financial position may change. I admit this is a fairly basic analysis for FLKS’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Flex Pharma to get a better picture of the stock by looking at:
- Historical Performance: What has FLKS’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.
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