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While small-cap stocks, such as Hilong Holding Limited (HKG:1623) with its market cap of HK$1.6b, 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, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. Nevertheless, this is just a partial view of the stock, and I recommend you dig deeper yourself into 1623 here.

Does 1623 Produce Much Cash Relative To Its Debt?

1623 has built up its total debt levels in the last twelve months, from CN¥2.4b to CN¥3.1b – this includes long-term debt. With this growth in debt, 1623's cash and short-term investments stands at CN¥705m to keep the business going. On top of this, 1623 has generated cash from operations of CN¥469m during the same period of time, resulting in an operating cash to total debt ratio of 15%, meaning that 1623’s operating cash is less than its debt.

Can 1623 meet its short-term obligations with the cash in hand?

With current liabilities at CN¥1.8b, it seems that the business has been able to meet these obligations given the level of current assets of CN¥4.0b, with a current ratio of 2.25x. The current ratio is calculated by dividing current assets by current liabilities. Generally, for Energy Services companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

Does 1623 face the risk of succumbing to its debt-load?

With debt reaching 87% of equity, 1623 may be thought of as relatively highly levered. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 1623's case, the ratio of 2.42x suggests that interest is not strongly covered, which means that debtors may be less inclined to loan the company more money, reducing its headroom for growth through debt.

Next Steps:

Although 1623’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Keep in mind I haven't considered other factors such as how 1623 has been performing in the past. I recommend you continue to research Hilong Holding to get a better picture of the small-cap by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for 1623’s future growth? Take a look at our free research report of analyst consensus for 1623’s outlook.

2. Valuation: What is 1623 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 1623 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.