Zero-debt allows substantial financial flexibility, especially for small-cap companies like 7digital Group plc (LON:7DIG), 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 7DIG 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.
See our latest analysis for 7digital Group
Is 7DIG 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. Either 7DIG 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. 7DIG’s revenue growth over the past year is a double-digit 49.8% which is considerably high for a small-cap company. 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.
Does 7DIG’s liquid assets cover its short-term commitments?
Since 7digital Group 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 7DIG’s most recent UK£12.0m liabilities, it seems that the business has been able to meet these commitments with a current assets level of UK£14.0m, leading to a 1.17x current account ratio. For Media companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Next Steps:
7DIG 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 7DIG’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure 7DIG has company-specific issues impacting its capital structure decisions. You should continue to research 7digital Group to get a more holistic view of the stock by looking at: