Zero-debt allows substantial financial flexibility, especially for small-cap companies like Visioneering Technologies Inc (ASX:VTI), 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 VTI has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
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Is VTI 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. Either VTI 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. VTI’s revenue growth over the past year was an impressively high triple-digit rate, therefore the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Does VTI’s liquid assets cover its short-term commitments?
Since Visioneering Technologies 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 US$1.8m, the company has been able to meet these commitments with a current assets level of US$11m, leading to a 5.97x current account ratio. However, a ratio above 3x may be considered excessive by some investors.
Next Steps:
VTI is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around VTI’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 VTI has company-specific issues impacting its capital structure decisions. I suggest you continue to research Visioneering Technologies to get a better picture of the stock by looking at: