How to determine the financial health of a business?

As we know, determining the business’s financial health is considered as crucial as running the business itself — it indicates the outcome of the business’s policies and operations in monetary terms.

Financial health is usually taken into consideration because of two factors. One is to evaluate the business’s sustainability and take corrective action if an error occurs. The other is to attract investors by sharing information about the business’s financial strength so they can invest with fewer worries and larger faith.

To manage the fiscal status of the business, many KPIs, ratios, and financial statement analyses keep in check the true picture of the business’s monetary health. In this blog, we will discuss some of them. So stick with us, and you’ll find it beneficial for your business.

Evaluating business financial health: 4 steps

Mainly there are four ways of determining financial health – balance sheet, income statement, cash flow statement, and financial ratios that help in imperative data collection and allow the business owner and financial managers to make robust decisions. Mentioning them as follows:

1. Balance Sheet

One prominent way to evaluate the business’s financial health is to analyze the balance sheet – a financial statement that depicts the business’s assets, liabilities, and owner’s equity at a particular point in time, be it half-yearly, yearly, or even quarterly. By analyzing these, you can gauge the following:

1. The liquidity position of the business
2. Debt position of the business in comparison to equity and fixed assets
3. Inventory and outstanding payments of the business

2. Income Statement

The other way you can determine financial health is by analyzing the business’s income statement. Thus, it shows the revenue, expenses including cost of production, salaries, rent, depreciation, etc., and profit earned by the business. By analyzing these metrics, you can easily understand the following aspects:

1. The gross profit margin for the goods
2. Net profit percentage of total revenue, i.e., how much expense accounts for total revenue
3. If the business has enough liquidity to pay interest or debt payments
4. Revenue growth over the years.
5. The shareholders’ share in the profits

3. Cash Flow Statement

As cash flow statement accounts for every cash transaction in a specified period. It maintains and accounts for every penny that flows through the business in different forms, be it operations, finances or investments. It is one of the main KPIs for measuring financial health because it shows a clear picture of the generation and utilization of cash.

By analyzing a cash flow statement, you can avoid unnecessary problems like delaying payments to employees, creditors, etc., during low cash flows by simply taking a short-term loan timely. During high cash flows, you can make investment decisions accordingly. Via cash flow analysis, you can get the following information:

1. The different sources of cash
2. The exact liquidity position of the business
3. Increase or decrease in cash generation or expenditure over the years

4. Financial ratios

Financial ratios provide a holistic view of the financial health of the business. This is because they show a comparative picture of different metrics. Though there are many financial ratios that you can use to determine the financial position of the business, here are the most important ones.

1. Liquidity Ratios
   They measure whether the business is in a position to pay its short-term liabilities or not.
2. Profitability Ratios
   Profitability ratios measure the business’s ability to make profits against its revenue and assets.
3. Solvency Ratios
   They measure a business’s ability to pay its long-term debts.
4. Leverage Ratios
   Leverage ratios measure how much business capital is sourced through debts.
5. Efficiency Ratios
   These ratios tell about the business’s expertise in properly utilizing its resources.

Ways to improve financial health

As we have discussed calculative steps – now it’s time to take efficient measures and procedures to tackle the same. So keep on reading.

1. Cut down Expenses, find cheaper alternatives, reduce debts, etc

One of the reliable ways to improve the bad financial health of the business is to cut down on unnecessary expenses and find more economical alternatives. For instance, do not recruit full-time position personnel when you can outsource or automate. You can also reduce debts by proactively managing and understanding your finances.

2. Invest wisely and create contingency funds

As who knows what the future holds? In times of a good business cycle, try to invest the extra amount in mutual funds, government bonds, other profitable businesses, etc. Also, consider creating contingency funds for financially bad business days.

3. Get Multiple channels of income

Do not rely on one income stream. As said by experts, it’s an era of multiple income streams. So, try to generate income through multiple income sources like diversifying your products, dividend or interest income, capital gains, rental income, etc.

4. Set effective budget plans and follow them

Another simple way to improve the bad financial health of the business is to set effective and robust budget plans. Moreover, following the budgets efficiently is as important as planning them. So remind yourself this every time while spending.

FAQs

1. What shows the financial health of a company?

There are different financial statements and ratios that show the financial health of a company. A solid-liquid position, well-balanced assets and liabilities, a proper plan for investments and liquidity, etc., show the business is in a good financial position.

2. State some financially healthy habits for a business

Some of the financially healthy habits for a business are:

1. Regularly reviewing and updating the financial plan
2. Setting financial goals with data analysis
3. Creating a viable budget
4. Find passive income to improve business income

3. What influences the financial health of the organization?

Factors like income, expenses, socio-economic background, financial literacy, etc., affect the financial health and well-being of the organization.

4. How is outsourcing services related to determining business financial health beneficial?

By outsourcing the services related to determining the business’s financial health, you put those in financial experts’ hands. This way, you get the reports prepared by the experts in the most economical way. It provides you with reliability, on-time advice, and more focused time on your core business.

How we can help!

To get a crystal clear picture of your business’s financial health, you should not depend on one financial statement or one financial ratio. Rather, you should analyze different financial metrics and then deduce a conclusion.

We at FinAccountants help businesses with world-class accounting and other services our team of professionals provides. With decades of experience, we can support your business’s needs in the best possible and economical manner.

Book a call NOW!