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While small-cap stocks, such as Far East Consortium International Limited (HKG:35) with its market cap of HK$8.1b, 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. Let's work through some financial health checks you may wish to consider if you're interested in this stock. However, potential investors would need to take a closer look, and I suggest you dig deeper yourself into 35 here.

35’s Debt (And Cash Flows)

Over the past year, 35 has ramped up its debt from HK$14b to HK$19b , which accounts for long term debt. With this growth in debt, the current cash and short-term investment levels stands at HK$5.9b to keep the business going. Moving on, operating cash flow was negative over the last twelve months. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can assess some of 35’s operating efficiency ratios such as ROA here.

Does 35’s liquid assets cover its short-term commitments?

With current liabilities at HK$8.5b, it appears that the company has been able to meet these commitments with a current assets level of HK$21b, leading to a 2.46x current account ratio. The current ratio is calculated by dividing current assets by current liabilities. For Real Estate 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.

Does 35 face the risk of succumbing to its debt-load?

35 is a highly-leveraged company with debt exceeding equity by over 100%. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established 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 before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 35's case, the ratio of 7.69x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as 35’s high interest coverage is seen as responsible and safe practice.