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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Oventus Medical Limited (ASX:OVN), 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 take you through a few basic checks to assess the financial health of companies with no debt.
Is OVN 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. OVN’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. OVN delivered a negative revenue growth of -11%. 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.
Does OVN’s liquid assets cover its short-term commitments?
Since Oventus Medical 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. Looking at OVN’s AU$726k in current liabilities, the company has been able to meet these obligations given the level of current assets of AU$7.8m, with a current ratio of 10.73x. However, many consider a ratio above 3x to be high.
Having no debt on the books means OVN has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around OVN’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. I admit this is a fairly basic analysis for OVN’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Oventus Medical to get a more holistic view of the stock by looking at:
- Historical Performance: What has OVN’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.
- 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.