Zero-debt allows substantial financial flexibility, especially for small-cap companies like Electro-Sensors Inc (NASDAQ:ELSE), 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 ELSE has no debt on its balance sheet, it doesn’t necessarily mean it exhibits 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 Electro-Sensors
Is ELSE growing fast enough to value financial flexibility over 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. ELSE’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. Opposite to the high growth we were expecting, ELSE’s negative revenue growth of -7.19% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can ELSE meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Electro-Sensors 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. With current liabilities at $0.5M, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 19.87x. However, anything about 3x may be excessive, since ELSE may be leaving too much capital in low-earning investments.
Are you a shareholder? As ELSE’s revenues are not growing at a fast enough pace, being in a zero-debt position isn’t always optimal. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and whether the company needs financial flexibility at this point in time. You should take a look into a future growth analysis to examine the company’s position.
Are you a potential investor? ELSE’s health in terms of financial liquidity should ease potential investors’ concerns. However, a relatively low revenue growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. I admit this is a fairly basic analysis for ELSE’s financial health. Other important fundamentals need to be considered alongside. I encourage you to continue your research by taking a look at ELSE’s past performance to figure out ELSE’s financial health position.
To help readers see pass 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.