Investors are always looking for growth in small-cap stocks like WPP AUNZ Limited (ASX:WPP), with a market cap of AU$715m. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health is vital, 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. However, this commentary is still very high-level, so I suggest you dig deeper yourself into WPP here.

How does WPP’s operating cash flow stack up against its debt?

WPP’s debt level has been constant at around AU$415m over the previous year – this includes both the current and long-term debt. At this stable level of debt, WPP’s cash and short-term investments stands at AU$129m for investing into the business. Moreover, WPP has generated AU$84m in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 20%, meaning that WPP’s current level of operating cash is high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In WPP’s case, it is able to generate 0.2x cash from its debt capital.

Can WPP pay its short-term liabilities?

At the current liabilities level of AU$902m liabilities, the company arguably has a rather low level of current assets relative its obligations, with the current ratio last standing at 0.86x.

Can WPP service its debt comfortably?

With a debt-to-equity ratio of 50%, WPP 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 test if WPP’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 WPP, the ratio of 11.15x suggests that interest is comfortably covered, which means that lenders may be less hesitant to lend out more funding as WPP’s high interest coverage is seen as responsible and safe practice.

Next Steps:

WPP’s debt and cash flow levels indicate room for improvement. Its cash flow coverage of less than a quarter of debt means that operating efficiency could be an issue. In addition to this, its low liquidity raises concerns over whether current asset management practices are properly implemented for the small-cap. This is only a rough assessment of financial health, and I’m sure WPP has company-specific issues impacting its capital structure decisions. I suggest you continue to research WPP AUNZ to get a more holistic view of the stock by looking at: