Armour Energy Limited (ASX:AJQ) is a small-cap stock with a market capitalization of AU$32.82M. 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? Companies operating in the Oil and Gas industry, especially ones that are currently loss-making, tend to be high risk. Evaluating financial health as part of your investment thesis is vital. Here are few basic financial health checks you should consider before taking the plunge. Nevertheless, given that I have not delve into the company-specifics, I suggest you dig deeper yourself into AJQ here.

Does AJQ generate an acceptable amount of cash through operations?

AJQ has built up its total debt levels in the last twelve months, from AU$12.87M to AU$29.28M , which is made up of current and long term debt. With this growth in debt, AJQ’s cash and short-term investments stands at AU$7.71M for investing into the business. Moving onto cash from operations, its trivial cash flows from operations make the cash-to-debt ratio less useful to us, though these low levels of cash means that operational efficiency is worth a look. 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 AJQ’s operating efficiency ratios such as ROA here.

Can AJQ pay its short-term liabilities?

With current liabilities at AU$6.87M, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.38x. Generally, for Oil and Gas companies, this is a reasonable ratio since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.

Can AJQ service its debt comfortably?

With a debt-to-equity ratio of 59.69%, AJQ can be considered as an above-average leveraged company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. However, since AJQ 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:

AJQ’s debt and cash flow levels indicate room for improvement. Its cash flow coverage of less than a quarter of debt means that operating efficiency could be an issue. However, the company exhibits an ability to meet its near term obligations should an adverse event occur. I admit this is a fairly basic analysis for AJQ’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Armour Energy to get a better picture of the stock 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.