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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Ziptel Limited (ASX:ZIP), 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 ZIP has outstanding financial strength. I will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
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Is ZIP right in choosing financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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. ZIP’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. ZIP delivered a negative revenue growth of -87.9%. 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.
Does ZIP’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Ziptel 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. With current liabilities at AU$145.4k, the company has been able to meet these obligations given the level of current assets of AU$1.7m, with a current ratio of 11.48x. Having said that, a ratio greater than 3x may be considered as quite high, and some might argue ZIP could be holding too much capital in a low-return investment environment.
Next Steps:
ZIP 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 ZIP’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 ZIP has company-specific issues impacting its capital structure decisions. I recommend you continue to research Ziptel to get a more holistic view of the stock by looking at: