The direct benefit for ID Systems Inc (NASDAQ:IDSY), 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 IDSY will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean IDSY has outstanding financial strength. I recommend you look at the following hurdles to assess IDSY’s financial health.
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Is IDSY right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. IDSY’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 double-digit revenue growth of 39.5% is considered relatively high for a small-cap company like IDSY. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Can IDSY pay its short-term liabilities?
Since I.D. Systems 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. With current liabilities at US$18.6m, it seems that the business has been able to meet these commitments with a current assets level of US$30.1m, leading to a 1.62x current account ratio. For Electronic companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Next Steps:
Having no debt on the books means IDSY has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around IDSY’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure IDSY has company-specific issues impacting its capital structure decisions. You should continue to research I.D. Systems to get a better picture of the stock by looking at: