Tesserent Limited (ASX:TNT), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is TNT will have to follow strict debt obligations which will reduce its financial flexibility. While TNT has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I recommend you look at the following hurdles to assess TNT’s financial health.
Check out our latest analysis for Tesserent
Does TNT’s growth rate justify its decision for 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. TNT’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. TNT delivered a negative revenue growth of -0.9%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can TNT pay its short-term liabilities?
Since Tesserent 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. 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. With current liabilities at AU$2m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.23x. Generally, for Software companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Next Steps:
As a high-growth company, it may be beneficial for TNT to have some financial flexibility, hence zero-debt. Since there is also no concerns around TNT’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure TNT has company-specific issues impacting its capital structure decisions. I recommend you continue to research Tesserent to get a more holistic view of the stock by looking at: