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While small-cap stocks, such as Korporacja Gospodarcza efekt S.A. (WSE:EFK) with its market cap of zł39m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Understanding the company's financial health becomes vital, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. Nevertheless, potential investors would need to take a closer look, and I’d encourage you to dig deeper yourself into EFK here.
Does EFK Produce Much Cash Relative To Its Debt?
EFK has shrunk its total debt levels in the last twelve months, from zł60m to zł56m – this includes long-term debt. With this reduction in debt, the current cash and short-term investment levels stands at zł12m , ready to be used for running the business. Additionally, EFK has produced cash from operations of zł13m over the same time period, resulting in an operating cash to total debt ratio of 23%, indicating that EFK’s operating cash is sufficient to cover its debt.
Does EFK’s liquid assets cover its short-term commitments?
With current liabilities at zł16m, the company may not have an easy time meeting these commitments with a current assets level of zł15m, leading to a current ratio of 0.93x. The current ratio is calculated by dividing current assets by current liabilities.
Can EFK service its debt comfortably?
Since total debt levels exceed equity, EFK is a highly leveraged company. 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 test if EFK’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 EFK, the ratio of 6.33x 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.
Next Steps:
EFK’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 raises questions over current asset management practices for the small-cap. I admit this is a fairly basic analysis for EFK's financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Korporacja Gospodarcza efekt to get a more holistic view of the stock by looking at: