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The direct benefit for Decimal Software Limited (ASX:DSX), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is DSX will have to adhere to stricter debt covenants and have less financial flexibility. 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 will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status. Check out our latest analysis for Decimal Software
Is financial flexibility worth the lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. DSX’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. Opposite to the high growth we were expecting, DSX’s negative revenue growth of -10.42% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does DSX’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Decimal Software 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. Looking at DSX’s most recent AU$762.56K liabilities, the company has been able to meet these commitments with a current assets level of AU$2.67M, leading to a 3.5x current account ratio. Though, anything above 3x is considered high and could mean that DSX has too much idle capital in low-earning investments.
Next Steps:
As DSX’s revenues are not growing at a fast enough pace, not taking advantage of lower cost debt may not be the best strategy. As shareholders, you should try and determine whether this strategy is justified for DSX, and whether the company needs financial flexibility at this point in time. I admit this is a fairly basic analysis for DSX’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Decimal Software to get a more holistic view of the stock by looking at: