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While small-cap stocks, such as Grand Baoxin Auto Group Limited (HKG:1293) with its market cap of HK$7.4b, 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 crucial, since poor capital management may bring about 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. Nevertheless, this is just a partial view of the stock, and I’d encourage you to dig deeper yourself into 1293 here.

Does 1293 Produce Much Cash Relative To Its Debt?

Over the past year, 1293 has ramped up its debt from CN¥9.0b to CN¥9.9b – this includes long-term debt. With this rise in debt, 1293's cash and short-term investments stands at CN¥2.6b to keep the business going. Additionally, 1293 has generated cash from operations of CN¥707m during the same period of time, resulting in an operating cash to total debt ratio of 7.1%, indicating that 1293’s debt is not covered by operating cash.

Does 1293’s liquid assets cover its short-term commitments?

With current liabilities at CN¥14b, it appears that the company has been able to meet these obligations given the level of current assets of CN¥20b, with a current ratio of 1.42x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Specialty Retail companies, this is a suitable ratio as there's enough of a cash buffer without holding too much capital in low return investments.

Is 1293’s debt level acceptable?

With total debt exceeding equity, 1293 is considered a highly levered company. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. We can test if 1293’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 1293, the ratio of 2.55x suggests that interest is not strongly covered, which means that lenders may be more reluctant to lend out more funding as 1293’s low interest coverage already puts the company at higher risk of default.

Next Steps:

1293’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. Since there is also no concerns around 1293's liquidity needs, this may be its optimal capital structure for the time being. Keep in mind I haven't considered other factors such as how 1293 has been performing in the past. I recommend you continue to research Grand Baoxin Auto Group to get a more holistic view of the small-cap by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for 1293’s future growth? Take a look at our free research report of analyst consensus for 1293’s outlook.

2. Valuation: What is 1293 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 1293 is currently mispriced by the market.

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.