While small-cap stocks, such as China Recycling Energy Corporation (NASDAQ:CREG) with its market cap of USD $10.51M, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Why is it important? A major downturn in the energy industry has resulted in over 150 companies going bankrupt and has put more than 100 on the verge of a collapse, primarily due to excessive debt. Here are few basic financial health checks to judge whether a company fits the bill or there is an additional risk which you should consider before taking the plunge. Check out our latest analysis for China Recycling Energy

Does CREG 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. Furthermore, failure to service debt can hurt its reputation, making funding expensive in the future. 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. CREG’s recent operating cash flow was 0.29 times its debt within the past year. A ratio of over a 0.25x is a positive sign and shows that CREG is generating ample cash from its core business, which should increase its potential to pay back near-term debt.

Does CREG’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, CREG could be required to liquidate some of its assets to meet these upcoming payments, as cash flow from operations is hindered. We should examine if the company’s cash and short-term investment levels match its current liabilities. Our analysis shows that CREG is able to meet its upcoming commitments with its cash and other short-term assets, which lessens our concerns for the company’s business operations should any unfavourable circumstances arise.

Can CREG service its debt comfortably?

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 CREG, the debt-to-equity ratio is 23.72%, which means its risk of facing a debt-overhang is very low. While debt-to-equity ratio has several factors at play, an easier way to check whether CREG’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. CREG’s interest on debt is not strongly covered by earnings as it sits at around 0.72x. Debtors may be less inclined to loan the company more money, giving CREG less headroom for growth through debt.