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While small-cap stocks, such as Tonking New Energy Group Holdings Limited (HKG:8326) with its market cap of HK$187m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Understanding the company's financial health becomes crucial, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Let's work through some financial health checks you may wish to consider if you're interested in this stock. However, these checks don't give you a full picture, so I’d encourage you to dig deeper yourself into 8326 here.

8326’s Debt (And Cash Flows)

Over the past year, 8326 has ramped up its debt from HK$101m to HK$144m , which is mainly comprised of near term debt. With this growth in debt, the current cash and short-term investment levels stands at HK$82m , ready to be used for running the business. Its negative operating cash flow means calculating cash-to-debt wouldn't be useful. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can take a look at some of 8326’s operating efficiency ratios such as ROA here.

Does 8326’s liquid assets cover its short-term commitments?

With current liabilities at HK$256m, the company has been able to meet these obligations given the level of current assets of HK$434m, with a current ratio of 1.69x. The current ratio is calculated by dividing current assets by current liabilities. Generally, for Hospitality companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

Is 8326’s debt level acceptable?

With debt reaching 62% of equity, 8326 may be thought of as relatively highly levered. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can test if 8326’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For 8326, the ratio of 7.92x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving 8326 ample headroom to grow its debt facilities.

Next Steps:

Although 8326’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. Since there is also no concerns around 8326's liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I'm sure 8326 has company-specific issues impacting its capital structure decisions. You should continue to research Tonking New Energy Group Holdings to get a more holistic view of the small-cap by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for 8326’s future growth? Take a look at our free research report of analyst consensus for 8326’s outlook.

2. Historical Performance: What has 8326'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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.