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While small-cap stocks, such as ImExHS Limited (ASX:IME) with its market cap of AU$29m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Software companies, even ones that are profitable, are more likely to be higher risk. Assessing first and foremost the financial health is essential. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Nevertheless, given that I have not delve into the company-specifics, I’d encourage you to dig deeper yourself into IME here.
Does IME produce enough cash relative to debt?
Over the past year, IME has borrowed debt capital of around AU$458k , which is mainly comprised of near term debt. With this ramp up in debt, IME currently has below A$10K remaining in cash and short-term investment, which is concerning. On top of this, its trivial cash flows from operations make the cash-to-debt ratio less useful to us, though these low levels of cash means that operational efficiency is worth a look. For this article’s sake, I won’t be looking at this today, but you can examine some of IME’s operating efficiency ratios such as ROA here.
Can IME meet its short-term obligations with the cash in hand?
Looking at IME’s AU$1.8m in current liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.59x. Usually, for Software companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Can IME service its debt comfortably?
With a debt-to-equity ratio of 25%, IME’s debt level may be seen as prudent. IME is not taking on too much debt commitment, which can be restrictive and risky for equity-holders. We can test if IME’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 IME, the ratio of 1.94x suggests that interest is not strongly covered, which means that lenders may be more reluctant to lend out more funding as IME’s low interest coverage already puts the company at higher risk of default.
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IME’s debt level is appropriate for a company its size, and it is also able to generate sufficient cash flow coverage, meaning it has been able to put its debt in good use. Furthermore, the company will be able to pay all of its upcoming liabilities from its current short-term assets. Keep in mind I haven’t considered other factors such as how IME has been performing in the past. I suggest you continue to research ImExHS to get a more holistic view of the stock by looking at: