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Zero-debt allows substantial financial flexibility, especially for small-cap companies like KNeoMedia Limited (ASX:KNM), 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.
Check out our latest analysis for KNeoMedia
Is KNM growing fast enough to value 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. The lack of debt on KNM’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 KNM is a high-growth company. KNM’s revenue growth over the past year was an impressively high triple-digit rate, 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.
Does KNM’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, KNeoMedia has no solvency issues, which is 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$393k, it appears that the company has been able to meet these obligations given the level of current assets of AU$3.7m, with a current ratio of 9.35x. However, a ratio greater than 3x may be considered high by some.
Next Steps:
As a high-growth company, it may be beneficial for KNM to have some financial flexibility, hence zero-debt. Since there is also no concerns around KNM’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. I admit this is a fairly basic analysis for KNM’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research KNeoMedia to get a better picture of the stock by looking at: