Zero-debt allows substantial financial flexibility, especially for small-cap companies like Acorn International Inc (NYSE:ATV), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean ATV has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. Check out our latest analysis for Acorn International
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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. ATV’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. A double-digit revenue growth of 23.13% is considered relatively high for a small-cap company like ATV. 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 ATV’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Acorn International has no solvency issues, which is 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. Looking at ATV’s most recent US$11.61m liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.73x. For Online Retail companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Having no debt on the books means ATV has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around ATV’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, ATV’s financial situation may change. Keep in mind I haven’t considered other factors such as how ATV has been performing in the past. I recommend you continue to research Acorn International to get a more holistic view of the stock by looking at:
- Historical Performance: What has ATV’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.