While small-cap stocks, such as Big Sofa Technologies Group PLC (AIM:BST) with its market cap of GBP £7.92M, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Internet Software and Services companies, in particular ones that run negative earnings, are more likely to be higher risk. Evaluating financial health as part of your investment thesis is crucial. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Though, given that I have not delve into the company-specifics, I recommend you dig deeper yourself into BST here.
Does BST generate an acceptable amount of cash through operations?
Over the past year, BST has ramped up its debt from £0M to £1M made up of predominantly near term debt. With this growth in debt, BST currently has £3M remaining in cash and short-term investments for investing into the business. However, 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 BST’s operating efficiency ratios such as ROA here.
Can BST pay its short-term liabilities?
At the current liabilities level of £1M liabilities, the company has been able to meet these obligations given the level of current assets of £3M, with a current ratio of 2.93x. Usually, for internet software and services companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Can BST service its debt comfortably?
BST is a highly-leveraged company with debt exceeding equity by over 100%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. But since BST is presently loss-making, there’s a question of sustainability of its current operations. Running high debt, while not yet making money, can be risky in unexpected downturns as liquidity may dry up, making it hard to operate.
Next Steps:
Are you a shareholder? BST’s high debt level indicates room for improvement. Furthermore, its cash flow coverage of less than a quarter of debt means that operating efficiency could also be an issue. In addition to this, the company may not be able to pay all of its upcoming liabilities from its current short-term assets. Moving forward, its financial position may be different. You should always be researching market expectations for BST’s future growth on our free analysis platform.