While small-cap stocks, such as Oldfields Holdings Limited (ASX:OLH) with its market cap of AU$5.8m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Assessing first and foremost the financial health is vital, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. However, given that I have not delve into the company-specifics, I suggest you dig deeper yourself into OLH here.

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

OLH’s debt levels have fallen from AU$6.3m to AU$3.8m over the last 12 months , which also accounts for long term debt. With this debt repayment, OLH’s cash and short-term investments stands at AU$720k for investing into the business. On top of this, OLH has generated cash from operations of AU$1.4m during the same period of time, leading to an operating cash to total debt ratio of 36%, meaning that OLH’s current level of operating cash is high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In OLH’s case, it is able to generate 0.36x cash from its debt capital.

Can OLH pay its short-term liabilities?

At the current liabilities level of AU$4.7m, it seems that the business has been able to meet these obligations given the level of current assets of AU$6.9m, with a current ratio of 1.49x. Generally, for Machinery companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.

Can OLH service its debt comfortably?

With a debt-to-equity ratio of 71%, OLH can be considered as an above-average leveraged company. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. 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 OLH’s case, the ratio of 0.71x suggests that interest is not strongly covered, which means that debtors may be less inclined to loan the company more money, reducing its headroom for growth through debt.

Next Steps:

Although OLH’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Keep in mind I haven’t considered other factors such as how OLH has been performing in the past. You should continue to research Oldfields Holdings to get a more holistic view of the small-cap by looking at:

1. Valuation: What is OLH worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether OLH is currently mispriced by the market.

2. Historical Performance: What has OLH’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.

3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.