While small-cap stocks, such as Nanjing Sample Technology Company Limited (HKG:1708) with its market cap of HK$7.0b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Companies operating in the Electronic industry, even ones that are profitable, are more likely to be higher risk. Assessing first and foremost the financial health is crucial. 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 1708 here.

How much cash does 1708 generate through its operations?

1708’s debt levels surged from CN¥504m to CN¥1.0b over the last 12 months – this includes long-term debt. With this rise in debt, 1708’s cash and short-term investments stands at CN¥716m , 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. For this article’s sake, I won’t be looking at this today, but you can examine some of 1708’s operating efficiency ratios such as ROA here.

Does 1708’s liquid assets cover its short-term commitments?

Looking at 1708’s CN¥2.1b 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 1.86x. Usually, for Electronic companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.

Is 1708’s debt level acceptable?

With a debt-to-equity ratio of 49%, 1708 can be considered as an above-average leveraged company. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can check to see whether 1708 is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 1708’s, case, the ratio of 7.78x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving 1708 ample headroom to grow its debt facilities.

Next Steps:

1708’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. Since there is also no concerns around 1708’s liquidity needs, this may be its optimal capital structure for the time being. Keep in mind I haven’t considered other factors such as how 1708 has been performing in the past. You should continue to research Nanjing Sample Technology to get a more holistic view of the small-cap by looking at: