Zero-debt allows substantial financial flexibility, especially for small-cap companies like BSQUARE Corporation (NASDAQ:BSQR), 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 go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
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. The lack of debt on BSQR’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 BSQR is a high-growth company. Opposite to the high growth we were expecting, BSQR’s negative revenue growth of -14% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can BSQR pay its short-term liabilities?
Given zero long-term debt on its balance sheet, BSQUARE 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 BSQR’s most recent US$13m liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.52x. 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.
Having no debt on the books means BSQR has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around BSQR’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, BSQR’s financial situation may change. This is only a rough assessment of financial health, and I’m sure BSQR has company-specific issues impacting its capital structure decisions. I recommend you continue to research BSQUARE to get a better picture of the stock by looking at:
- Historical Performance: What has BSQR’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.