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While small-cap stocks, such as IPH Limited (ASX:IPH) with its market cap of AU$1.1b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Evaluating financial health as part of your investment thesis is essential, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Nevertheless, this commentary is still very high-level, so I recommend you dig deeper yourself into IPH here.
Does IPH produce enough cash relative to debt?
Over the past year, IPH has ramped up its debt from AU$200k to AU$40m – this includes long-term debt. With this increase in debt, IPH currently has AU$26m remaining in cash and short-term investments for investing into the business. Moreover, IPH has produced cash from operations of AU$46m in the last twelve months, leading to an operating cash to total debt ratio of 115%, signalling that IPH’s current level of operating cash is high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In IPH’s case, it is able to generate 1.15x cash from its debt capital.
Can IPH pay its short-term liabilities?
With current liabilities at AU$33m, it appears that the company has been able to meet these commitments with a current assets level of AU$89m, leading to a 2.72x current account ratio. Usually, for Professional Services companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Is IPH’s debt level acceptable?
With debt at 15% of equity, IPH may be thought of as appropriately levered. IPH is not taking on too much debt commitment, which can be restrictive and risky for equity-holders. We can check to see whether IPH 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 IPH’s, case, the ratio of 38.18x suggests that interest is comfortably covered, which means that lenders may be less hesitant to lend out more funding as IPH’s high interest coverage is seen as responsible and safe practice.
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IPH’s high cash coverage and low debt levels indicate its ability to utilise its borrowings efficiently in order to generate ample cash flow. Furthermore, the company exhibits an ability to meet its near term obligations should an adverse event occur. Keep in mind I haven’t considered other factors such as how IPH has been performing in the past. I recommend you continue to research IPH to get a more holistic view of the stock by looking at: