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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Hawkstone Mining Limited (ASX:HWK), 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 recommend you look at the following hurdles to assess HWK’s financial health.

View our latest analysis for Hawkstone Mining

Does HWK’s growth rate justify its decision for 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. Either HWK 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. Opposite to the high growth we were expecting, HWK’s negative revenue growth of -69% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.

Can HWK meet its short-term obligations with the cash in hand?

Since Hawkstone Mining 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 AU$167k, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 5.92x. Having said that, a ratio above 3x may be considered excessive by some investors.

Next Steps:

Having no debt on the books means HWK has more financial freedom to keep growing at its current fast rate. 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 HWK has been performing in the past. I recommend you continue to research Hawkstone Mining to get a more holistic view of the stock by looking at:

1. Historical Performance: What has HWK’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.