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While small-cap stocks, such as Heidelberger Druckmaschinen Aktiengesellschaft (FRA:HDD) with its market cap of €427m, 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. Nevertheless, potential investors would need to take a closer look, and I suggest you dig deeper yourself into HDD here.

HDD’s Debt (And Cash Flows)

HDD has built up its total debt levels in the last twelve months, from €438m to €465m , which accounts for long term debt. With this growth in debt, the current cash and short-term investment levels stands at €215m , ready to be used for running the business. We note it produced negative cash flow over the last twelve months. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can take a look at some of HDD’s operating efficiency ratios such as ROA here.

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

With current liabilities at €834m, the company has been able to meet these obligations given the level of current assets of €1.4b, with a current ratio of 1.64x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Machinery companies, this is a suitable ratio since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

Can HDD service its debt comfortably?

Since total debt levels exceed equity, HDD is a highly leveraged company. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In HDD's case, the ratio of 2.46x suggests that interest is not strongly covered, which means that debtors may be less inclined to loan the company more money, reducing its headroom for growth through debt.

Next Steps:

Although HDD’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. Since there is also no concerns around HDD's liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I'm sure HDD has company-specific issues impacting its capital structure decisions. I suggest you continue to research Heidelberger Druckmaschinen to get a better picture of the small-cap by looking at:

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

2. Valuation: What is HDD 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 HDD 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.