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While small-cap stocks, such as Contact Energy Limited (NZSE:CEN) with its market cap of NZ$4.9b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Assessing first and foremost the financial health is vital, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. However, these checks don't give you a full picture, so I recommend you dig deeper yourself into CEN here.

Does CEN Produce Much Cash Relative To Its Debt?

CEN's debt levels have fallen from NZ$1.6b to NZ$1.2b over the last 12 months – this includes long-term debt. With this reduction in debt, the current cash and short-term investment levels stands at NZ$210m to keep the business going. Additionally, CEN has generated cash from operations of NZ$509m over the same time period, resulting in an operating cash to total debt ratio of 42%, meaning that CEN’s debt is appropriately covered by operating cash.

Can CEN meet its short-term obligations with the cash in hand?

With current liabilities at NZ$611m, it seems that the business arguably has a rather low level of current assets relative its obligations, with the current ratio last standing at 0.73x. The current ratio is calculated by dividing current assets by current liabilities.

Can CEN service its debt comfortably?

With a debt-to-equity ratio of 42%, CEN can be considered as an above-average leveraged company. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. We can check to see whether CEN is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In CEN's, case, the ratio of 3.74x suggests that interest is appropriately covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.

Next Steps:

CEN’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. However, its lack of liquidity raises questions over current asset management practices for the small-cap. This is only a rough assessment of financial health, and I'm sure CEN has company-specific issues impacting its capital structure decisions. I suggest you continue to research Contact Energy to get a more holistic view of the stock by looking at:

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

2. Valuation: What is CEN worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether CEN is currently mispriced by the market.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.