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While small-cap stocks, such as Hope Education Group Co., Ltd. (HKG:1765) 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 essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. However, these checks don't give you a full picture, so I suggest you dig deeper yourself into 1765 here.

1765’s Debt (And Cash Flows)

Over the past year, 1765 has reduced its debt from CN¥2.9b to CN¥2.2b , which includes long-term debt. With this reduction in debt, 1765 currently has CN¥3.0b remaining in cash and short-term investments to keep the business going. On top of this, 1765 has produced CN¥802m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 36%, signalling that 1765’s debt is appropriately covered by operating cash.

Can 1765 pay its short-term liabilities?

At the current liabilities level of CN¥1.9b, it appears that the company has been able to meet these obligations given the level of current assets of CN¥3.2b, with a current ratio of 1.71x. The current ratio is calculated by dividing current assets by current liabilities. Generally, for Consumer Services companies, this is a reasonable ratio as there's enough of a cash buffer without holding too much capital in low return investments.

Can 1765 service its debt comfortably?

With a debt-to-equity ratio of 53%, 1765 can be considered as an above-average leveraged 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 1765’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 1765, the ratio of 1.46x suggests that interest is not strongly covered, which means that lenders may refuse to lend the company more money, as it is seen as too risky in terms of default.

Next Steps:

1765’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. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. I admit this is a fairly basic analysis for 1765's financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Hope Education Group to get a better picture of the small-cap by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for 1765’s future growth? Take a look at our free research report of analyst consensus for 1765’s outlook.

2. Valuation: What is 1765 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 1765 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.