While small-cap stocks, such as Daido Group Limited (SEHK:544) with its market cap of HK$177.56M, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Since 544 is loss-making right now, it’s crucial to evaluate the current state of its operations and pathway to profitability. Here are few basic financial health checks you should consider before taking the plunge. However, given that I have not delve into the company-specifics, I’d encourage you to dig deeper yourself into 544 here.

How does 544’s operating cash flow stack up against its debt?

Over the past year, 544 has maintained its debt levels at around HK$141.78M comprising of short- and long-term debt. At this current level of debt, the current cash and short-term investment levels stands at HK$161.77M for investing into the business. Additionally, 544 has produced cash from operations of HK$45.50M in the last twelve months, leading to an operating cash to total debt ratio of 32.09%, signalling that 544’s operating cash is sufficient to cover its debt. This ratio can also be a sign of operational efficiency for loss making companies as traditional metrics such as return on asset (ROA) requires a positive net income. In 544’s case, it is able to generate 0.32x cash from its debt capital.

Does 544’s liquid assets cover its short-term commitments?

With current liabilities at HK$72.32M, the company has been able to meet these obligations given the level of current assets of HK$242.32M, with a current ratio of 3.35x. However, anything above 3x is considered high and could mean that 544 has too much idle capital in low-earning investments.

Does 544 face the risk of succumbing to its debt-load?

544 is a relatively highly levered company with a debt-to-equity of 55.97%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. However, since 544 is presently unprofitable, sustainability of its current state of operations becomes a concern. Maintaining a high level of debt, while revenues are still below costs, can be dangerous as liquidity tends to dry up in unexpected downturns.

Next Steps:

Although 544’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. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. This is only a rough assessment of financial health, and I’m sure 544 has company-specific issues impacting its capital structure decisions. I recommend you continue to research Daido Group to get a better picture of the small-cap by looking at the areas below. Just a heads up – to access some parts of the Simply Wall St research tool you might be asked to create a free account, but it takes just one click and the information they provide is definitely worth it in my opinion.