The direct benefit for TSR Inc (NASDAQ:TSRI), 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 TSRI will have to adhere to stricter debt covenants and have less 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 TSRI’s financial health. Check out our latest analysis for TSR
Does TSRI’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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. Either TSRI does not have access to cheap capital, or it may believe this trade-off is not worth it. This makes sense only if the company has a competitive edge and is growing fast off its equity capital. A single-digit revenue growth of 2.58% for TSRI is considerably low for a small-cap company. More capital can help the business grow faster. If TSRI is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can TSRI meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, TSR 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. At the current liabilities level of $6.8M liabilities, it appears that the company has been able to meet these commitments with a current assets level of $14.5M, leading to a 2.13x current account ratio. For it companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too capital in low return investments.
Are you a shareholder? As TSRI’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. I suggest you take a look into a future growth analysis to examine what the market expects for the company moving forward.
Are you a potential investor? The company’s current holding of liquid assets gives it some level of security in any case of adverse events. But, its low sales growth means there’s potential to improve return on capital by taking on some debt and ramp up growth. This is only a rough assessment of financial health, and I’m sure TSRI has company-specific issues impacting its capital structure decisions. I encourage you to continue your research by taking a look at TSRI’s past performance to figure out TSRI’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.