The direct benefit for Nvoi Limited (ASX:NVO), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is NVO will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean NVO has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Is NVO 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. The lack of debt on NVO’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 NVO is a high-growth company. NVO delivered a strikingly high triple-digit revenue growth over the past year, 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 NVO’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Nvoi 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. Looking at NVO’s AU$249k in current liabilities, it appears that the company has been able to meet these commitments with a current assets level of AU$1.5m, leading to a 5.86x current account ratio. Having said that, many consider a ratio above 3x to be high.
NVO 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 NVO’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. Keep in mind I haven’t considered other factors such as how NVO has been performing in the past. I recommend you continue to research Nvoi to get a more holistic view of the stock by looking at:
- Historical Performance: What has NVO’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.
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 email@example.com.