Investors are always looking for growth in small-cap stocks like 88 Energy Limited (ASX:88E), with a market cap of AUD A$88.34M. However, an important fact which most ignore is: how financially healthy is the company? The significance of doing due diligence on a company’s financial strength stems from the fact that over 20,000 companies go bankrupt in every quarter in the US alone. These factors make a basic understanding of a company’s financial position of utmost importance for a potential investor. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. See our latest analysis for 88E

Does 88E generate an acceptable amount of cash through operations?

Unxpected adverse events, such as natural disasters and wars, can be a true test of a company’s capacity to meet its obligations. These catastrophes does not mean the company can stop servicing its debt obligations. Can 88E pay off what it owes to its debtholder by using only cash from its operational activities? In the case of 88E, operating cash flow turned out to be -0.13x its debt level over the past twelve months. This means what 88E can generate on an annual basis, which is currently a negative value, does not cover what it actually owes its debtors in the near term. This raises a red flag, looking at 88E’s operations at this point in time.

Can 88E meet its short-term obligations with the cash in hand?

What about its commitments to other stakeholders such as payments to suppliers and employees? As cash flow from operation is hindered by adverse events, 88E may need to liquidate its short-term assets to meet these upcoming payments. We test for 88E’s ability to meet these needs by comparing its cash and short-term investments with current liabilities. Our analysis shows that 88E does not have enough liquid assets on hand to meet its upcoming liabilities. Though this is a common practice, since cash is better utilized invested in the business or returned to shareholders, it does raise some concerns for investors should adverse events arise.

Does 88E face the risk of succumbing to its debt-load?

While ideally the debt-to equity ratio of a financially healthy company should be less than 40%, several factors such as industry life-cycle and economic conditions can result in a company raising a significant amount of debt. In the case of 88E, the debt-to-equity ratio is 38.92%, which means its risk of facing a debt-overhang is very low.

Next Steps:

Are you a shareholder? Although 88E’s debt level is relatively low, its cash flow levels still could not copiously cover its borrowings. This may indicate room for improvement in terms of its operating efficiency. Furthermore, the company may struggle to meet its near term liabilities should an adverse event occur. Given that 88E’s financial situation may change. You should always be keeping on top of market expectations for 88E’s future growth on our free analysis platform.

Are you a potential investor? 88E seems to have maintained a sensible level of debt, which means there’s still some headroom to grow debt funding. But its current cash flow coverage of existing debt, in addition to the low liquidity, is concerning. However, keep in mind that this is a point-in-time analysis, and today’s performance may not be representative of 88E’s track record. You should continue your analysis by taking a look at 88E’s past performance analysis on our free platform to figure out 88E’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.