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Sarla Performance Fibers Limited (NSE:SARLAPOLY) is a small-cap stock with a market capitalization of ₹2.8b. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? So, understanding the company’s financial health becomes essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. Though, this commentary is still very high-level, so I recommend you dig deeper yourself into SARLAPOLY here.
How much cash does SARLAPOLY generate through its operations?
SARLAPOLY has shrunken its total debt levels in the last twelve months, from ₹2.6b to ₹2.2b , which is made up of current and long term debt. With this reduction in debt, SARLAPOLY’s cash and short-term investments stands at ₹223m for investing into the business. On top of this, SARLAPOLY has generated ₹490m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 22%, meaning that SARLAPOLY’s operating cash is sufficient to cover its debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In SARLAPOLY’s case, it is able to generate 0.22x cash from its debt capital.
Can SARLAPOLY meet its short-term obligations with the cash in hand?
Looking at SARLAPOLY’s most recent ₹1.4b 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 1.45x. Usually, for Luxury companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Can SARLAPOLY service its debt comfortably?
SARLAPOLY is a relatively highly levered company with a debt-to-equity of 80%. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can test if SARLAPOLY’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 SARLAPOLY, the ratio of 55.69x suggests that interest is comfortably covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.