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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Ahsay Backup Software Development Company Limited (HKG:8290), 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 8290’s financial health.
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Is 8290 growing fast enough to value financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. 8290’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. A single-digit revenue growth of 4.8% for 8290 is considerably low for a small-cap company. More capital can help the business grow faster. If 8290 is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can 8290 meet its short-term obligations with the cash in hand?
Since Ahsay Backup Software Development 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. Looking at 8290’s most recent HK$20.2m liabilities, it appears that the company has been able to meet these commitments with a current assets level of HK$91.5m, leading to a 4.52x current account ratio. However, anything about 3x may be excessive, since 8290 may be leaving too much capital in low-earning investments.
Next Steps:
As a high-growth company, it may be beneficial for 8290 to have some financial flexibility, hence zero-debt. Since there is also no concerns around 8290’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, 8290’s financial situation may change. This is only a rough assessment of financial health, and I’m sure 8290 has company-specific issues impacting its capital structure decisions. I recommend you continue to research Ahsay Backup Software Development to get a more holistic view of the stock by looking at: