Simplicity Holding Limited (SEHK:8367) is a small-cap stock with a market capitalization of HK$168.80M. 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? Assessing first and foremost the financial health is essential, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. Nevertheless, this commentary is still very high-level, so I suggest you dig deeper yourself into 8367 here.

How does 8367’s operating cash flow stack up against its debt?

8367 has shrunken its total debt levels in the last twelve months, from HK$50.49M to HK$15.76M . With this debt payback, the current cash and short-term investment levels stands at HK$4.35M for investing into the business. Additionally, 8367 has produced HK$9.75M in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 61.88%, indicating that 8367’s debt is appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 8367’s case, it is able to generate 0.62x cash from its debt capital.

Can 8367 meet its short-term obligations with the cash in hand?

Looking at 8367’s most recent HK$27.23M liabilities, it seems that the business has not maintained a sufficient level of current assets to meet its obligations, with the current ratio last standing at 0.4x, which is below the prudent industry ratio of 3x.

Is 8367’s debt level acceptable?

8367’s level of debt is appropriate relative to its total equity, at 36.15%. This range is considered safe as 8367 is not taking on too much debt obligation, which can be restrictive and risky for equity-holders. We can check to see whether 8367 is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 8367’s, case, the ratio of 35.43x suggests that interest is comfortably 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.

Next Steps:

8367’s debt level is appropriate for a company its size. Furthermore, it is able to generate sufficient cash flow coverage, meaning it is able to put its debt in good use. Though its lack of liquidity raises questions over current asset management practices for the small-cap. This is only a rough assessment of financial health, and I’m sure 8367 has company-specific issues impacting its capital structure decisions. I suggest you continue to research Simplicity Holding 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.