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While small-cap stocks, such as Gear4music (Holdings) plc (LON:G4M) with its market cap of UK£39m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Assessing first and foremost the financial health is essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Let’s work through some financial health checks you may wish to consider if you’re interested in this stock. Nevertheless, potential investors would need to take a closer look, and I recommend you dig deeper yourself into G4M here.
G4M’s Debt (And Cash Flows)
G4M’s debt levels surged from UK£7.8m to UK£10m over the last 12 months – this includes long-term debt. With this rise in debt, the current cash and short-term investment levels stands at UK£2.7m , ready to be used for running the business. However, G4M is only producing UK£20k in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of under 1x, indicating that debt is not covered by operating cash.
Can G4M meet its short-term obligations with the cash in hand?
With current liabilities at UK£21m, it seems that the business has been able to meet these commitments with a current assets level of UK£28m, leading to a 1.34x current account ratio. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Specialty Retail companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Is G4M’s debt level acceptable?
With debt reaching 55% of equity, G4M may be thought of as relatively highly levered. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. We can check to see whether G4M 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 G4M’s, case, the ratio of 6.54x suggests that interest is appropriately covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.
G4M’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. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. I admit this is a fairly basic analysis for G4M’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Gear4music (Holdings) to get a more holistic view of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for G4M’s future growth? Take a look at our free research report of analyst consensus for G4M’s outlook.
- Historical Performance: What has G4M’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.
- 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.