adept4 plc (AIM:AD4) is a small-cap stock with a market capitalization of GBP £9.37M. 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? IT Services companies, especially ones that are currently loss-making, are more likely to be higher risk. So, understanding the company’s financial health becomes essential. I believe these basic checks tell most of the story you need to know. Nevertheless, I know these factors are very high-level, so I suggest you dig deeper yourself into AD4 here.
How does AD4’s operating cash flow stack up against its debt?
Over the past year, AD4 has ramped up its debt from £0M to £6M , which comprises of short- and long-term debt. With this increase in debt, AD4 currently has £4M remaining in cash and short-term investments for investing into the business. On top of this, AD4 has produced £1M in operating cash flow over the same time period, leading to an operating cash to total debt ratio of 0.18x, meaning that AD4’s operating cash is not sufficient to cover its debt. This ratio can also be a sign of operational efficiency for unprofitable businesses since metrics such as return on asset (ROA) requires a positive net income. In AD4’s case, it is able to generate 0.18x cash from its debt capital.
Can AD4 pay its short-term liabilities?
At the current liabilities level of £3M liabilities, the company has been able to meet these commitments with a current assets level of £6M, leading to a 1.75x current account ratio. Usually, for it services companies, this is a suitable ratio since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Can AD4 service its debt comfortably?
With debt reaching 82.78% of equity, AD4 may be thought of as relatively highly levered. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. However, since AD4 is presently unprofitable, sustainability of its current state of operations becomes a concern. Maintaining a high level of debt, while revenues are still below costs, can be dangerous as liquidity tends to dry up in unexpected downturns.
Next Steps:
Are you a shareholder? Although AD4’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. Since there is also no concerns around AD4’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, AD4’s financial situation may change. I suggest researching market expectations for AD4’s future growth on our free analysis platform.