While small-cap stocks, such as Inabox Group Limited (ASX:IAB) with its market cap of AUD A$23.35M, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. There are always disruptions which destabilize an existing industry, in which most small-cap companies are the first casualties. Thus, it becomes utmost important for an investor to test a company’s resilience for such contingencies. In simple terms, I believe these three small calculations tell most of the story you need to know. Check out our latest analysis for Inabox Group
Does IAB generate an acceptable amount of cash through operations?
There are many headwinds that come unannounced, such as natural disasters and political turmoil, which can challenge a small business and its ability to adapt and recover. These adverse events bring devastation and yet does not absolve the company from its debt. Can IAB pay off what it owes to its debtholder by using only cash from its operational activities? Last year, IAB’s operating cash flow was 0.31x its current debt. A ratio of over a 0.25x is a positive sign and shows that IAB is generating ample cash from its core business, which should increase its potential to pay back near-term debt.
Can IAB pay its short-term liabilities?
What about its commitments to other stakeholders such as payments to suppliers and employees? During times of unfavourable events, IAB could be required to liquidate some of its assets to meet these upcoming payments, as cash flow from operations is hindered. We test for IAB’s ability to meet these needs by comparing its cash and short-term investments with current liabilities. Our analysis shows that IAB is unable to meet all of its upcoming commitments with its cash and other short-term assets. While this is not abnormal for companies, as their cash is better invested in the business or returned to investors than lying around, it does bring about some concerns should any unfavourable circumstances arise.
Is IAB’s level of debt at an acceptable level?
Debt-to-equity ratio tells us how much of the asset debtors could claim if the company went out of business. In the case of IAB, the debt-to-equity ratio is 92.45%, which means that it is a highly leveraged company. This is not a problem if the company has consistently grown its profits. But during a business downturn, as liquidity may dry up, making it hard to operate. We can test if IAB’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings should cover interest by at least three times, therefore reducing concerns when profit is highly volatile. IAB’s interest on debt is not strongly covered by earnings as it sits at around 0.85x. This means lenders may refuse to lend the company more money, as it is seen as too risky in terms of default.
Are you a shareholder? IAB’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. Though its lack of liquidity means the company may be pressed to meet its short-term obligations, and increasing debt funding to meet these needs could prove difficult. In the future, its financial position may change. I suggest researching market expectations for IAB’s future growth on our free analysis platform.
Are you a potential investor? IAB’s high debt level shouldn’t scare off investors just yet. Its operating cash flow seems adequate to meet obligations which means its debt is being put to good use. However, the company may struggle to meet its near term liabilities should an adverse event occur. To gain more conviction in the stock, you need to further examine IAB’s track record. As a following step, you should take a look at IAB’s past performance analysis on our free platform in order to determine for yourself whether its debt position is justified.