Innovotech Inc (CVE:IOT), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is IOT will have to follow strict debt obligations which will reduce its financial flexibility. 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 recommend you look at the following hurdles to assess IOT’s financial health.
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. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. IOT’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. IOT delivered a negative revenue growth of -24.0%. 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.
Can IOT pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Innovotech 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 IOT’s most recent CA$253.4k liabilities, the company has been able to meet these obligations given the level of current assets of CA$256.9k, with a current ratio of 1.01x. Generally, for Life Sciences companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too capital in low return investments.
IOT 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 IOT’s liquidity needs, this may be its optimal capital structure for the time being. In the future, IOT’s financial situation may change. Keep in mind I haven’t considered other factors such as how IOT has been performing in the past. You should continue to research Innovotech to get a better picture of the stock by looking at:
- Historical Performance: What has IOT’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.
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