While small-cap stocks, such as South West Pinnacle Exploration Limited (NSE:SOUTHWEST) with its market cap of ₹906.8m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Evaluating financial health as part of your investment thesis is essential, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Though, since I only look at basic financial figures, I suggest you dig deeper yourself into SOUTHWEST here.

Does SOUTHWEST produce enough cash relative to debt?

SOUTHWEST has shrunken its total debt levels in the last twelve months, from ₹648.5m to ₹496.6m – this includes both the current and long-term debt. With this debt repayment, SOUTHWEST’s cash and short-term investments stands at ₹29.4m , ready to deploy into the business. Moving onto cash from operations, its operating cash flow is not yet significant enough to calculate a meaningful cash-to-debt ratio, indicating that operational efficiency is something we’d need to take a look at. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can take a look at some of SOUTHWEST’s operating efficiency ratios such as ROA here.

Does SOUTHWEST’s liquid assets cover its short-term commitments?

Looking at SOUTHWEST’s most recent ₹554.1m liabilities, it appears that the company has been able to meet these obligations given the level of current assets of ₹786.9m, with a current ratio of 1.42x. For Metals and Mining companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

Can SOUTHWEST service its debt comfortably?

With debt reaching 69.3% of equity, SOUTHWEST 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. We can test if SOUTHWEST’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 SOUTHWEST, the ratio of 2.96x 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:

SOUTHWEST’s cash flow coverage indicates it could improve its operating efficiency in order to meet demand for debt repayments should unforeseen events arise. However, the company exhibits proper management of current assets and upcoming liabilities. I admit this is a fairly basic analysis for SOUTHWEST’s financial health. Other important fundamentals need to be considered alongside. You should continue to research South West Pinnacle Exploration to get a more holistic view of the stock by looking at:

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

2. Historical Performance: What has SOUTHWEST’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.

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.