While small-cap stocks, such as Arvee Laboratories (India) Limited (NSE:ARVEE) with its market cap of ₹320m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Evaluating financial health as part of your investment thesis is vital, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. However, this commentary is still very high-level, so I’d encourage you to dig deeper yourself into ARVEE here.

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

Over the past year, ARVEE has reduced its debt from ₹250m to ₹161m , which is made up of current and long term debt. With this debt payback, ARVEE currently has ₹20m remaining in cash and short-term investments for investing into the business. Additionally, ARVEE has produced ₹60m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 37%, indicating that ARVEE’s current level of operating cash is high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In ARVEE’s case, it is able to generate 0.37x cash from its debt capital.

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

At the current liabilities level of ₹213m liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.28x. For Chemicals companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

Can ARVEE service its debt comfortably?

Since total debt levels have outpaced equities, ARVEE is a highly leveraged company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some 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 after interest and tax at least three times its net interest payments is considered financially sound. In ARVEE’s case, the ratio of 1.84x suggests that interest is not strongly covered, which means that lenders may refuse to lend the company more money, as it is seen as too risky in terms of default.

Next Steps:

ARVEE’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. 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 ARVEE’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Arvee Laboratories (India) to get a more holistic view of the small-cap by looking at: