Zero-debt allows substantial financial flexibility, especially for small-cap companies like Isentric Limited (ASX:ICU), 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 ICU 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. Check out our latest analysis for Isentric
Is ICU growing fast enough to value financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. The lack of debt on ICU’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if ICU is a high-growth company. ICU delivered a negative revenue growth of -20.37%. 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.
Can ICU pay its short-term liabilities?
Since Isentric 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. With current liabilities at A$1.4M liabilities, it appears that the company has been able to meet these commitments with a current assets level of A$4.1M, leading to a 2.89x current account ratio. For internet companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too capital in low return investments.
Next Steps:
Are you a shareholder? Since ICU is a low-growth stock in terms of its revenues, having no debt on its balance sheet isn’t necessarily the best thing. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and why financial flexibility is needed at this stage in its business cycle. I recommend taking a look into a future growth analysis to examine the company’s position.
Are you a potential investor? ICU’s management of short term liabilities is strong. However, its soft revenue growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. This is only a rough assessment of financial health, and I’m sure ICU has company-specific issues impacting its capital structure decisions. I encourage you to continue your research by taking a look at ICU’s past performance in order to determine for yourself whether its zero-debt position is justified.
To help readers see pass 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.