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Is Gear4music (Holdings) plc's (LON:G4M) Balance Sheet Strong Enough To Weather A Storm?

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Gear4music (Holdings) plc (LON:G4M) is a small-cap stock with a market capitalization of UK£39m. 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. Why is it important? 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. The following basic checks can help you get a picture of the company's balance sheet strength. Nevertheless, this is just a partial view of the stock, and I’d encourage you to dig deeper yourself into G4M here.

Does G4M Produce Much Cash Relative To Its Debt?

Over the past year, G4M has ramped up its debt from UK£7.8m to UK£10m , which accounts for long term debt. With this rise in debt, G4M's cash and short-term investments stands at UK£2.7m , ready to be used for running the business. However, G4M is only generating cash from operations of UK£20k during the same period of time, leading to an operating cash to total debt ratio of under 1x, meaning that its operating cash is less than its debt.

Can G4M pay its short-term liabilities?

At the current liabilities level of UK£21m, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.34x. The current ratio is calculated by dividing current assets by current liabilities. Generally, for Specialty Retail companies, this is a reasonable ratio since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

AIM:G4M Historical Debt, April 12th 2019
AIM:G4M Historical Debt, April 12th 2019

Can G4M service its debt comfortably?

With debt reaching 55% of equity, G4M may be thought of as relatively highly levered. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. 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.

Next Steps:

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 better picture of the small-cap by looking at:

  1. 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.

  2. 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.

  3. 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 editorial-team@simplywallst.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.