HOW TO CHECK THE FINANCIAL HEALTH OF YOUR BUSINESS?

HOW TO CHECK THE FINANCIAL HEALTH OF YOUR BUSINESS?

Business

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. 

If you are an entrepreneur, you often need to speak about the financial health of your business if you wish to attract investors, venture capitalists or seek loans. 

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. 

RATIOSDEFINITIONSFORMULASIDEAL RATIO
Net Profit MarginIndicates how much net income an organization makes with total sales achievedNet Profit/Net SalesHigher the better
Gross Profit MarginIndicates how much gross profit every dollar of revenue a company is earningGross Profit/Net SalesHigher the better
Inventory TurnoverThe rate that inventory stock is sold, used & replacedCost Of Goods Sold (COGS)/Average StockHigher the better
Current RatioCompares all of a company’s current assets to its current liabilitiesCurrent Assets/Current LiabilitiesHigher the better
Debt-to-equity ratioCalculates the value of total debt and financial liabilities against the total shareholder’s equityDebt/EquityShould be between 1 to 2. Anything above 2 is risky. 
Return on assetsMeasures how efficiently a company can earn a return on its investment in assetsNet Income/Total AssetsHigher the better
Return on equity Compares the annual net income of a business to its shareholders’ equityNet Income/Average Shareholder’s EquityHigher the better
Debt Service Coverage RatioMeasures available cash flow to pay current debt obligations.Net Operating Income/Debt ServiceHigher 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

HOW TO CHECK THE FINANCIAL HEALTH OF ANY BUSINESS?
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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

FINAL WORDS

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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