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Investors are always looking for growth in small-cap stocks like National Tyre & Wheel Limited (ASX:NTD), with a market cap of AU$47m. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. However, I know these factors are very high-level, so I recommend you dig deeper yourself into NTD here.

Does NTD produce enough cash relative to debt?

NTD’s debt levels surged from AU$8.2m to AU$14m over the last 12 months , which accounts for long term debt. With this rise in debt, NTD’s cash and short-term investments stands at AU$20m , ready to deploy into the business. Moreover, NTD has produced AU$8.9m in operating cash flow over the same time period, leading to an operating cash to total debt ratio of 62%, indicating that NTD’s current level of operating cash is high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In NTD’s case, it is able to generate 0.62x cash from its debt capital.

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

Looking at NTD’s AU$41m in current liabilities, it appears that the company has been able to meet these commitments with a current assets level of AU$96m, leading to a 2.34x current account ratio. For Retail Distributors companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too much capital in low return investments.

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

NTD’s level of debt is appropriate relative to its total equity, at 22%. NTD is not taking on too much debt commitment, which can be restrictive and risky for equity-holders. We can test if NTD’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 NTD, the ratio of 25.25x suggests that interest is comfortably covered, which means that lenders may be less hesitant to lend out more funding as NTD’s high interest coverage is seen as responsible and safe practice.

Next Steps:

NTD has demonstrated its ability to generate sufficient levels of cash flow, while its debt hovers at an appropriate level. Furthermore, the company exhibits an ability to meet its near term obligations should an adverse event occur. Keep in mind I haven’t considered other factors such as how NTD has been performing in the past. I suggest you continue to research National Tyre & Wheel to get a more holistic view of the stock by looking at:

1. Valuation: What is NTD 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 NTD is currently mispriced by the market.

2. Historical Performance: What has NTD’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.

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.