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While small-cap stocks, such as China Weaving Materials Holdings Limited (HKG:3778) with its market cap of HK$576m, 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 crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. Nevertheless, this is just a partial view of the stock, and I recommend you dig deeper yourself into 3778 here.

Does 3778 Produce Much Cash Relative To Its Debt?

Over the past year, 3778 has reduced its debt from CN¥653m to CN¥465m , which also accounts for long term debt. With this debt repayment, the current cash and short-term investment levels stands at CN¥48m to keep the business going. Moreover, 3778 has produced cash from operations of CN¥279m in the last twelve months, resulting in an operating cash to total debt ratio of 60%, indicating that 3778’s operating cash is sufficient to cover its debt.

Can 3778 meet its short-term obligations with the cash in hand?

At the current liabilities level of CN¥816m, the company may not have an easy time meeting these commitments with a current assets level of CN¥409m, leading to a current ratio of 0.5x. The current ratio is the number you get when you divide current assets by current liabilities.

Does 3778 face the risk of succumbing to its debt-load?

3778 is a relatively highly levered company with a debt-to-equity of 75%. 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 test if 3778’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 3778, the ratio of 3.36x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as 3778’s high interest coverage is seen as responsible and safe practice.

Next Steps:

Although 3778’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet debt obligations which means its debt is being efficiently utilised. But, its lack of liquidity raises questions over current asset management practices for the small-cap. I admit this is a fairly basic analysis for 3778's financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research China Weaving Materials Holdings to get a better picture of the stock by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for 3778’s future growth? Take a look at our free research report of analyst consensus for 3778’s outlook.

2. Valuation: What is 3778 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 3778 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.