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Zero-debt allows substantial financial flexibility, especially for small-cap companies like DataDot Technology Limited (ASX:DDT), 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 will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.

See our latest analysis for DataDot Technology

Does DDT’s growth rate justify its decision for financial flexibility over lower cost of capital?

Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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 DDT 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. Opposite to the high growth we were expecting, DDT’s negative revenue growth of -8.9% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.

Can DDT pay its short-term liabilities?

Since DataDot Technology 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. At the current liabilities level of AU$1.1m, the company has been able to meet these obligations given the level of current assets of AU$2.7m, with a current ratio of 2.51x. For Auto Components companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too much capital in low return investments.

Next Steps:

Having no debt on the books means DDT has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, DDT’s financial situation may change. This is only a rough assessment of financial health, and I’m sure DDT has company-specific issues impacting its capital structure decisions. I suggest you continue to research DataDot Technology to get a better picture of the stock by looking at: