While small-cap stocks, such as Hudson Investment Group Limited (ASX:HGL) with its market cap of AU$11m, 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. I believe these basic checks tell most of the story you need to know. Though, I know these factors are very high-level, so I suggest you dig deeper yourself into HGL here.

How much cash does HGL generate through its operations?

Over the past year, HGL has reduced its debt from AU$8.0m to AU$7.5m , which also accounts for long term debt. With this debt payback, HGL’s cash and short-term investments stands at AU$3.1m for investing into the business. However, HGL is only generating AU$49k in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of under 1x, indicating that debt is not appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In HGL’s case, it generates less than 1x cash from its debt capital.

Can HGL pay its short-term liabilities?

At the current liabilities level of AU$11m, the company arguably has a rather low level of current assets relative its obligations, with the current ratio last standing at 0.27x.

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

HGL is a relatively highly levered company with a debt-to-equity of 71%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can check to see whether HGL 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 HGL’s, case, the ratio of 1x 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:

HGL’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. However, its low liquidity raises concerns over whether current asset management practices are properly implemented for the small-cap. I admit this is a fairly basic analysis for HGL’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Hudson Investment Group to get a more holistic view of the stock by looking at:

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

2. Valuation: What is HGL 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 HGL 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.

To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.