Investors are always looking for growth in small-cap stocks like Po Valley Energy Limited (ASX:PVE), with a market cap of AUD A$24.92M. However, an important fact which most ignore is: how financially healthy is the company? Why is it important? A major downturn in the energy industry has resulted in over 150 companies going bankrupt and has put more than 100 on the verge of a collapse, primarily due to excessive debt. These factors make a basic understanding of a company’s financial position of utmost importance for a potential investor. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. View our latest analysis for Po Valley Energy

Does PVE generate an acceptable amount of cash through operations?

While failure to manage cash has been one of the major reasons behind the demise of a lot of small businesses, mismanagement comes into the light during tough situations such as an economic recession. These catastrophes does not mean the company can stop servicing its debt obligations. We can test the impact of these adverse events by looking at whether cash from its current operations can pay back its current debt obligations. PVE’s recent operating cash flow was -4.49 times its debt within the past year. This means what PVE can generate on an annual basis, which is currently a negative value, does not cover what it actually owes its debtors in the near term. This raises a red flag, looking at PVE’s operations at this point in time.

Can PVE meet its short-term obligations with the cash in hand?

What about its other commitments such as payments to suppliers and salaries to its employees? During times of unfavourable events, PVE could be required to liquidate some of its assets to meet these upcoming payments, as cash flow from operations is hindered. We should examine if the company’s cash and short-term investment levels match its current liabilities. Our analysis shows that PVE is unable to meet all of its upcoming commitments with its cash and other short-term assets. While this is not abnormal for companies, as their cash is better invested in the business or returned to investors than lying around, it does bring about some concerns should any unfavourable circumstances arise.

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

While ideally the debt-to equity ratio of a financially healthy company should be less than 40%, several factors such as industry life-cycle and economic conditions can result in a company raising a significant amount of debt. PVE’s debt-to-equity ratio stands at 7.01%, which means debt is low and does not pose any significant threat to the company’s operations.

Next Steps:

Are you a shareholder? Although PVE’s debt level is relatively low, its cash flow levels still could not copiously cover its borrowings. This may indicate room for improvement in terms of its operating efficiency. Furthermore, the company may struggle to meet its near term liabilities should an adverse event occur. Given that PVE’s financial situation may change. You should always be researching market expectations for PVE’s future growth on our free analysis platform.

Are you a potential investor? PVE appears to have maintained a sensible level of debt, which means there’s still some headroom to grow debt funding. But its current cash flow coverage of existing debt, in addition to the low liquidity, is concerning. However, keep in mind that this is a point-in-time analysis, and today’s performance may not be representative of PVE’s track record. I encourage you to continue your research by taking a look at PVE’s past performance analysis on our free platform to figure out PVE’s financial health position.

To help readers see pass 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.