Conducting financial health checks and constant monitoring of a company’s finances is a necessary skill essential for the smooth functioning of any organization. This not only helps in getting a clear picture of how your business is performing but also helps in making more informed decisions.
Let’s quickly look at some of the financial health factors that you must access:
Analyzing the Balance Sheet
“The balance sheet is the company’s thermometer. It lets you know whether you’re healthy or not.”
A balance is a financial statement that shows a company’s financial position by reporting a company’s assets, liabilities and owners’ equity at a specific point in time.
Assets are what a business owns and liabilities are what a business owes. Owners’ equity represents the financing that owners put into the business.
Assets should equal the owners’ equity and liabilities’ sum.
Assets = Owners’ Equity + Liabilities
Financial Ratio Analysis
Financial ratios help you make sense of the numbers presented in financial statements. It gives insights into your company’s liquidity, operational efficiency, and profitability. Some of the financial ratios that you should know are Gross Profit Margin, Net Profit margin, Inventory Turnover, Current Ratio, Debt-to-equity ratio, Debt Service Coverage Ratio, Return on Equity and Return on Assets.
To check whether your company is improving or declining, financial ratios should be compared across periods and against competitors.
|Net Profit Margin||Indicates how much net income an organization makes with total sales achieved||Net Profit/Net Sales||Higher the better|
|Gross Profit Margin||Indicates how much gross profit every dollar of revenue a company is earning||Gross Profit/Net Sales||Higher the better|
|Inventory Turnover||The rate that inventory stock is sold, used & replaced||Cost Of Goods Sold (COGS)/Average Stock||Higher the better|
|Current Ratio||Compares all of a company’s current assets to its current liabilities||Current Assets/Current Liabilities||Higher the better|
|Debt-to-equity ratio||Calculates the value of total debt and financial liabilities against the total shareholder’s equity||Debt/Equity||Should be between 1 to 2. Anything above 2 is risky.|
|Return on assets||Measures how efficiently a company can earn a return on its investment in assets||Net Income/Total Assets||Higher the better|
|Return on equity||Compares the annual net income of a business to its shareholders’ equity||Net Income/Average Shareholder’s Equity||Higher the better|
|Debt Service Coverage Ratio||Measures available cash flow to pay current debt obligations.||Net Operating Income/Debt Service||Higher the better. A higher ratio indicates that the company is generating enough profits to repay its debts.|
Analyzing Income Statement
An income statement shows you the company’s income and expenditures. By assessing the income statement, you can understand your business’s financial health by calculating:
i) Revenue Growth over specific accounting periods
ii) Net profit’s revenue after all expenses are paid
iii) The gross profit margin for the products/services sold
iv) If your company can cover its debt interest repayments
Analyze the Cash Flow Statement
It is another vital metric for financial health checking as it provides aggregate data regarding all cash inflows a company receives from its ongoing internal and external investment sources.
A low cash flow indicates difficult and challenging times for employees, suppliers, and creditors among others. You can take the necessary steps required to correct it if you assess it beforehand. You should analyze:
i) The liquidity situation
ii) The cash sources of the company
iii) The free cash flow that the company generates for further investment in assets
iv) Whether the cash has increased or decreased
You can perform the above analysis to know the financial health of your business. Always remember, whether you are a business owner, entrepreneur, employee, or investor, understanding the financial health of your business is as vital as it can be.
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