Soon Mining Limited (ASX:SMG) is a small-cap stock with a market capitalization of AUD A$41.14M. 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. The significance of doing due diligence on a company’s financial strength stems from the fact that over 20,000 companies go bankrupt in every quarter in the US alone. These factors make a basic understanding of a company’s financial position of utmost importance for a potential 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 Soon Mining

Does SMG generate enough 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 catastrophes does not mean the company can stop servicing its debt obligations. We can test the impact of these adverse events by looking at whether cash from its current operations can pay back its current debt obligations. SMG’s recent operating cash flow was -16.49 times its debt within the past year. This means what SMG can generate on an annual basis, which is currently a negative value, does not cover what it actually owes its debtors in the near term. This raises a red flag, looking at SMG’s operations at this point in time.

Does SMG’s liquid assets cover its short-term commitments?

What about its other commitments such as payments to suppliers and salaries to its employees? During times of unfavourable events, SMG could be required to liquidate some of its assets to meet these upcoming payments, as cash flow from operations is hindered. We test for SMG’s ability to meet these needs by comparing its cash and short-term investments with current liabilities. Our analysis shows that SMG does have enough liquid assets on hand to meet its upcoming liabilities, which lowers our concerns should adverse events arise.

Does SMG face the risk of succumbing to its debt-load?

While ideally the debt-to equity ratio of a financially healthy company should be less than 40%, several factors such as industry life-cycle and economic conditions can result in a company raising a significant amount of debt. For SMG, the debt-to-equity ratio is 2.76%, which indicates that the company faces low risk associated with debt. While debt-to-equity ratio has several factors at play, an easier way to check whether SMG’s leverage is at a sustainable level is to check its ability to service the debt. A company generating earnings at least three times its interest payments is considered financially sound. In SMG’s case, its interest is excessively covered by its earnings as the ratio sits at 24.53x. Debtors may be willing to loan the company more money, giving SMG ample headroom to grow its debt facilities.

Next Steps:

Are you a shareholder? Although SMG’s debt level is relatively low, its cash flow levels still could not copiously cover its borrowings. This may indicate room for improvement in terms of its operating efficiency. Though, the company will be able to pay all of its upcoming liabilities from its current short-term assets. Given that its financial position may change. I suggest researching market expectations for SMG’s future growth on our free analysis platform.

Are you a potential investor? Soon Mining currently has financial flexibility to ramp up growth in the future. Furthermore, its high liquidity means the company should continue to operate smoothly in the case of adverse events. To gain more confidence in the stock, you need to also examine the company’s track record. I encourage you to continue your research by taking a look at SMG’s past performance analysis on our free platform to conclude on SMG’s financial health.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.