Zero-debt allows substantial financial flexibility, especially for small-cap companies like LiveTiles Limited (ASX:LVT), 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 recommend you look at the following hurdles to assess LVT’s financial health.

View our latest analysis for LiveTiles

Is financial flexibility worth the lower cost of capital?

There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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. LVT’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. LVT’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 LVT’s liquid assets cover its short-term commitments?

Given zero long-term debt on its balance sheet, LiveTiles 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$9.4m, the company has been able to meet these obligations given the level of current assets of AU$22m, with a current ratio of 2.38x. Usually, for Software companies, this is a suitable ratio 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 LVT 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. Moving forward, its financial position may be different. Keep in mind I haven’t considered other factors such as how LVT has been performing in the past. You should continue to research LiveTiles to get a better picture of the stock by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for LVT’s future growth? Take a look at our free research report of analyst consensus for LVT’s outlook.

2. Historical Performance: What has LVT’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.

3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.