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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Golden Valley Mines Ltd. (CVE:GZZ), 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.

See our latest analysis for Golden Valley Mines

Is financial flexibility worth the 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. Either GZZ does not have access to cheap capital, or it may believe this trade-off is not worth it. This makes sense only if the company has a competitive edge and is growing fast off its equity capital. GZZ’s revenue growth over the past year is an impressively high double-digit 85%. 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.

Can GZZ pay its short-term liabilities?

Since Golden Valley Mines 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 CA$1.5m, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 3.74x. Having said that, many consider a ratio above 3x to be high.

Next Steps:

Having no debt on the books means GZZ has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around GZZ’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, GZZ’s financial situation may change. I admit this is a fairly basic analysis for GZZ’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Golden Valley Mines to get a better picture of the stock by looking at:

1. Historical Performance: What has GZZ’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.

2. 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 editorial-team@simplywallst.com.