Ridley Corporation Limited (ASX:RIC) is a small-cap stock with a market capitalization of AUD A$429.40M. 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. 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. Thus, it becomes utmost important for an investor to test a company’s resilience for such contingencies. In simple terms, I believe these three small calculations tell most of the story you need to know. See our latest analysis for RIC

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

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 RIC pay off what it owes to its debtholder by using only cash from its operational activities? In the case of RIC, operating cash flow turned out to be 0.44x its debt level over the past twelve months. A ratio of over a 0.25x is a positive sign and shows that RIC is generating ample cash from its core business, which should increase its potential to pay back near-term debt.

Can RIC pay its short-term liabilities?

What about its commitments to other stakeholders such as payments to suppliers and employees? As cash flow from operation is hindered by adverse events, RIC may need to liquidate its short-term assets to meet these upcoming payments. We test for RIC’s ability to meet these needs by comparing its cash and short-term investments with current liabilities. Our analysis shows that RIC does have enough liquid assets on hand to meet its upcoming liabilities, which lowers our concerns should adverse events arise.

Does RIC 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 RIC, the debt-to-equity ratio is 26.20%, which means its debt level does not pose a threat to its operations right now. While debt-to-equity ratio has several factors at play, an easier way to check whether RIC’s leverage is at a sustainable level is to check its ability to service the debt. A company generating earnings at least three times its interest payments is considered financially sound. RIC’s interest on debt is sufficiently covered by earnings as it sits at around 5.7x. This means lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.

Next Steps:

Are you a shareholder? RIC has demonstrated its ability to generate sufficient levels of cash flow, while its debt hovers at an appropriate level. Furthermore, the company exhibits an ability to meet its near term obligations should an adverse event occur. Going forward, RIC’s financial situation may change. You should always be researching market expectations for RIC’s future growth on our free analysis platform.

Are you a potential investor? Although RIC’s debt level is relatively low, it has the ability to efficiently utilise its borrowings to generate ample cash flow coverage. In addition, its high liquidity ensures the company will continue to operate smoothly should unfavourable circumstances arise. To gain more confidence in the stock, you need to also examine RIC’s track record. As a following step, you should take a look at RIC’s past performance analysis on our free platform to conclude on RIC’s financial health.

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.