Avi Lipa

Let's measure how your Business's Financial Health is doing..

Updated: Feb 10, 2023

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Knowing how to determine the financial health of a company is a vital business skill.

If you own a business or are an entrepreneur, you need to know how your business is doing for a number of reasons. Having a clear picture of the financial health of your organization can help you make better decisions about its direction and how its resources are used. In the same way, if you want to attract investors or get money for your business, you need to talk about its financial health.

If you're a manager, you need to know how your company's finances are doing so you can better lead your team. Without this knowledge, it can be easy to pursue projects that don't have a clear return on investment or initiatives that don't help your company grow.

As an employee, it can also help you to know how well your company is doing financially. You can ask for a promotion or raise at the right time if you know when your boss is doing well. When you see that your boss is having trouble, you can take steps to prove your worth or look for work somewhere else.

There are many ways to measure a company's financial health, but one of the best is to look at its financial statements. Here are some different kinds of analyses you can do to learn more about your company's financial health.

Here are 4 WAYS to Determine the

Financial Health of a Company

1. Analyze the Balance Sheet

The balance sheet is a statement that shows how much money a company has and how much it owes. It gives a quick look at the company's assets, debts, and owners' equity.

A company's assets are the things it needs to run its business.

Liabilities are money that a company has borrowed from other people and needs to pay back.

The money that private or public owners put into a business is called "owners' equity."

It's important to remember that the total of assets, liabilities, and owners' equity should always be the same.

This is the relationship that the accounting equation is based on:

Assets = Liabilities + Owners’ Equity

On the balance sheet, both assets and liabilities are shown as either current or non-current, which shows whether they are short-term or long-term. Short-term assets are those that are expected to be turned into cash within a year, while long-term assets are those that are not expected to be turned into cash within a year. On the other hand, short-term liabilities are those that are due within a year, while long-term liabilities are those that are not due within a year.

The balance sheet tells you about the health of a company's finances by helping you look at:

🟠 How much debt a company has compared to how much money it has.

🟠 How well the business can pay its bills in the short term (less than one year)

🟠 How much of the assets can be touched and how much comes from financial transactions?

🟠 How long it takes for customers to pay what they owe and pay back suppliers.

🟠 How long it takes to sell all of the stock that a business has.

2. Look at the Profit and Loss Statement

The income statement looks at a company's income, expenses, and profits to show how well it did financially over a certain time period. A trial balance of transactions from any two points in time can be used to make it for any time period.

To find the gross profit, the income statement usually starts with the money made during the period minus the cost of making the goods that were sold. It then takes out all other costs, like staff salaries, rent, electricity, and non-cash costs like depreciation, to find the earnings before interest and tax (EBIT). Lastly, it takes out the money paid for interest and taxes to find the owners' net profit. This money can be given back to the company as dividends or put back into the business.

The income statement tells you about the health of a company's finances by helping you look at:

🟠 How much more money is coming in during different accounting periods

🟠 The amount of money made from selling goods.

🟠 How much of a percentage of sales leads to a net profit after all costs?

🟠 If the company can pay the interest on its debts,

🟠 How much a business pays back to shareholders and how much it puts back into the business.

3. Look at the statement of cash flows.

The cash flow statement shows in detail how a company spent its cash over the course of an accounting period. It shows where the money came from and where it went, broken down into operations, investments, and financing activities. Lastly, it compares the cash balances at the beginning and end of the period.

One of the most important documents used to analyze a company's finances is the cash flow statement, which shows how cash is made and spent. The income statement and balance sheet are based on accrual accounting, which doesn't always match up with how much cash the business actually moves around. This is why there is a cash flow statement: to take out the effects of non-cash transactions and give managers, owners, and investors a clearer picture of the company's finances.

The cash flow statement tells you about the financial health of a company by helping you analyze:

🟠 How much money the company has on hand

🟠 How the company gets money

🟠 The company's free cash flow is the money it has left over after paying its bills.

🟠 Whether the total amount of cash has gone up or down.

4. Analysis of Financial Ratios

Financial ratios help you make sense of the numbers in your company's financial statements. They are also powerful tools for figuring out how healthy your company's finances are as a whole. Ratios can be put into many different groups, such as profitability, liquidity, solvency, efficiency, valuation, and value.

You should know about some of the following financial ratios:

🟠 Gross profit margin: The amount of profit a company makes after deducting the direct cost of sales from its revenue.

🟠 Net profit margin is the percentage of profit a company makes after all costs, such as interest and taxes, have been taken out of revenue.

🟠 Coverage ratio is a measure of a company's ability to pay its bills, especially its debt and interest payments.

🟠 Current ratio: The company's ability to pay off short-term debts in less than a year

🟠 Quick ratio: A measure of a company's ability to pay short-term debts due in less than a year with only its most liquid assets.

🟠 Debt-to-equity ratio: The ratio of how much debt a company has to how much equity it has.

🟠 Inventory turnover: How many times the whole stock was sold in a given time frame

🟠 Total asset turnover is a measure of how well a company makes money from its total assets.

🟠 Return on equity (ROE) is a measure of how well a company can make money off of its own investments.

🟠 Return on assets (ROA) is a measure of how well a company can manage and use its assets to make money.

Financial ratios should be compared between different time periods and to competitors to see if your company is getting better or worse and how it compares to direct and indirect competitors in the same industry. No single ratio or statement is enough to figure out how well your business is doing financially as a whole. Instead, a mix of ratio analyses should be used across all statements.

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All professionals, including business owners, entrepreneurs, employees, and investors, need to know how healthy a company's finances are. By looking at the information in financial statements, you can find out how healthy your company's finances are and use the information to make decisions that will help your business and your career.