While small-cap stocks, such as Ching Lee Holdings Limited (HKG:3728) with its market cap of HK$253m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. So, understanding the company’s financial health becomes crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. Though, I know these factors are very high-level, so I suggest you dig deeper yourself into 3728 here.

How does 3728’s operating cash flow stack up against its debt?

3728’s debt levels surged from HK$57m to HK$149m over the last 12 months made up of predominantly near term debt. With this rise in debt, 3728 currently has HK$77m remaining in cash and short-term investments , ready to deploy into the business. Moving onto cash from operations, its small level of operating cash flow means calculating cash-to-debt wouldn’t be too useful, though these low levels of cash means that operational efficiency is worth a look. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can examine some of 3728’s operating efficiency ratios such as ROA here.

Does 3728’s liquid assets cover its short-term commitments?

At the current liabilities level of HK$355m, the company has been able to meet these commitments with a current assets level of HK$407m, leading to a 1.15x current account ratio. Usually, for Construction companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

Does 3728 face the risk of succumbing to its debt-load?

With total debt exceeding equities, 3728 is considered a highly levered company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can test if 3728’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For 3728, the ratio of 8.01x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving 3728 ample headroom to grow its debt facilities.

Next Steps:

Although 3728’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. I admit this is a fairly basic analysis for 3728’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Ching Lee Holdings to get a better picture of the small-cap by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for 3728’s future growth? Take a look at our free research report of analyst consensus for 3728’s outlook.

2. Historical Performance: What has 3728’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.

3. 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 editorial-team@simplywallst.com.