Investors are always looking for growth in small-cap stocks like AWF Madison Group Limited (NZSE:AWF), with a market cap of NZ$60m. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health is crucial, 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. However, given that I have not delve into the company-specifics, I’d encourage you to dig deeper yourself into AWF here.
How does AWF’s operating cash flow stack up against its debt?
Over the past year, AWF has ramped up its debt from NZ$34m to NZ$36m – this includes both the current and long-term debt. With this increase in debt, AWF’s cash and short-term investments stands at NZ$6m , ready to deploy into the business. On top of this, AWF has produced cash from operations of NZ$12m during the same period of time, leading to an operating cash to total debt ratio of 32%, indicating that AWF’s operating cash is sufficient to cover its debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In AWF’s case, it is able to generate 0.32x cash from its debt capital.
Can AWF pay its short-term liabilities?
With current liabilities at NZ$30m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.62x. For Professional Services companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too much capital in low return investments.
Is AWF’s debt level acceptable?
AWF is a relatively highly levered company with a debt-to-equity of 98%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some 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 after interest and tax at least three times its net interest payments is considered financially sound. In AWF’s case, the ratio of 6.49x suggests that interest is appropriately covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.
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AWF’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. 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 AWF has company-specific issues impacting its capital structure decisions. I recommend you continue to research AWF Madison Group to get a better picture of the small-cap by looking at: