Hop Fung Group Holdings Limited (HKG:2320) is a small-cap stock with a market capitalization of HK$414.3m. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? So, understanding the company’s financial health becomes essential, 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. Though, this commentary is still very high-level, so I suggest you dig deeper yourself into 2320 here.

Does 2320 produce enough cash relative to debt?

2320’s debt levels surged from HK$94.1m to HK$231.4m over the last 12 months , which is made up of current and long term debt. With this growth in debt, the current cash and short-term investment levels stands at HK$253.2m for investing into the business. Moving onto cash from operations, its operating cash flow is not yet significant enough to calculate a meaningful cash-to-debt ratio, indicating that operational efficiency is something we’d need to take a look at. For this article’s sake, I won’t be looking at this today, but you can examine some of 2320’s operating efficiency ratios such as ROA here.

Can 2320 meet its short-term obligations with the cash in hand?

With current liabilities at HK$420.8m, it seems that the business has been able to meet these commitments with a current assets level of HK$734.3m, leading to a 1.74x current account ratio. Generally, for Packaging companies, this is a reasonable ratio since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.

Is 2320’s debt level acceptable?

2320’s level of debt is appropriate relative to its total equity, at 14.1%. This range is considered safe as 2320 is not taking on too much debt obligation, which may be constraining for future growth. We can test if 2320’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 2320, the ratio of 103x suggests that interest is comfortably covered, which means that lenders may be less hesitant to lend out more funding as 2320’s high interest coverage is seen as responsible and safe practice.

Next Steps:

2320’s low debt is also met with low coverage. This indicates room for improvement as its cash flow covers less than a quarter of its borrowings, which means its operating efficiency could be better. However, the company exhibits proper management of current assets and upcoming liabilities. Keep in mind I haven’t considered other factors such as how 2320 has been performing in the past. You should continue to research Hop Fung Group Holdings to get a better picture of the stock by looking at: