Aeris Resources Limited (ASX:AIS) is a small-cap-stock with a market capitalization of USD $5 Million. 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. There are always disruptions which destabilize and many a times end an existing industry, and most small-cap companies are the first casualties when such a wave hits.
Apart from a major industry-downturn like in the energy sector, it can be anything from natural calamity; political unrest; economic collapse; labor-strike; supply-chain disruption; or even a major factory breakdown, which may test a company’s financial resilience. These factors make a basic understanding of a company’s financial position of utmost importance for a new investor. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. View our latest analysis for Aeris Resources
Does Aeris Resources generate an acceptable amount of cash through operations?
More than the revenue shown on paper, what matters is how much cash is generated through operations and whether it is enough to continue operations, meet debt-obligations and fund growth . For Aeris Resources the ratio of operating cash flow to overall debt stands at 9.5%. A figure of less than 10% is alarming, although short-term obstacles and cyclical nature of an industry may have an impact on a company’s ability to generate cash.
Can AIS meet its short-term obligations with the cash in hand?
While failure to manage cash has been one of the major reasons behind the demise of a lot of small businesses, the mismanagement comes into the limelight during tough situations such as economic recession, war, natural disaster, sudden increase in the price of raw materials, and a supply chain risk, which can put a company in a difficult situation . For a small company, that could be a death blow if it doesn’t have enough reserves to meet its short-term obligations – payments to suppliers, wages, short-term bank loans, interest on long-term debt. Aeris Resources is able to meet its short term (1 year) commitments with its holdings of cash and other short term assets.
Does Aeris Resources face the risk of succumbing to its debt-load?
Debt to equity ratio tells you if the company faces tough times or goes out of business, how much assets the debtors could claim. In the case of Aeris Resources, the debt-to-equity ratio is 286% and this means that Aeris Resources is a highly leveraged company, which can be fine if the company has consistently improved its Return on Equity. But a business downturn may dry up its liquidity, making it hard to operate . No matter how high is the debt, if a company can easily cover the interest payments, it’s considered to be making a good use of that excessive leverage. To keep an eye on how it’s doing on that front, an investor can check how easily the company can service its debt. If it earns at least 5x or more of its interest payments, that’s an indication of financial strength. In AIS’s case the interest on debt is not strongly covered (ideally 5x) by earnings (earnings are 1.8x annual interest expense).
Final words
These balance sheet checks are a fine starting point to decide whether a company is worth your consideration; however, its growth profile and track record are equally important in deciding whether it’s doing better than its peers. I recommend you see our latest FREE analysis on Aeris Resources.
