02 Apr How Can Businesses Measure Their Financial Health
Every business should be financially healthy to succeed. But it is a common misconception that a business should have no liability to be considered financially healthy. This is actually a myth. The most important thing about financial health is that the money is moving—money is coming in as well as coming out. It’s also worth noting that the money coming in should be more than what is going out.
How can businesses measure their financial health?
There are four important factors that need to be understood. These are:
This is the most important indicator that the business is healthy. Remember that the measurement of profitability is not on the actual amount of the profit but the net margin. The net margin is the ratio of net profits to revenues. It is identified by percentage. The millions you deemed you earned from the business do not sound much if the net margin is hovering around 1%. Greater profit and greater net margin mean a greater sense of financial stability, which essentially states that the business is in good financial health.
This refers to the ready cash the company has in its coffers in order to pay obligations. Liquidity refers to the actual cash on hand and the assets that are easily convertible to cash. There are two ways to measure liquidity:
- QUICK RATIO. This is also called the acid-test ratio. This is important in determining how well a company can satisfy short-term fiscal obligations. The formula goes: cash + marketable securities + accounts receivable. When the quick ratio falls to less than 1, it’s not a good sign.
- CURRENT RATIO. This is also another method to check out the company’s liquidity.
This is just like liquidity but with a longer timeframe in mind. So if the company has long-term debts, as most companies should have, then solvency indicates the company’s ability to pay off such debts. Sources include company assets and equity. The debt-to-equity could measure a company’s long-term sustainability.
This is the key to a business’s financial success. This essentially measures the company’s profit margin following the deduction of the cost of production and marketing of products and services offered by the company.
Now that you have a basic understanding of how can businesses measure their financial health, and you know the indicators of a financially healthy business, it is time to actually measure one’s financial health.
Here are the best ways to assess whether your company is in good financial health or not.
More Income, Less Expense
This is actually more or less a given. To earn profits from the business, owners and managers should receive more money than what they release. That means more income and fewer expenses.
Expect some challenges when it comes to measuring income and expenses, though. There are some account inputs where it would be hard to identify the specific account as either income or expenses when it could easily be just a transfer of accounts. A business is financially healthy if its managers are adept at overseeing the flow of money—from income to expense. This is also indicative of the business’s resiliency toward unexpected financial issues.
Bills Paid On Time
How is this some sort-of measurement, you may ask—well, this is part of the goings-on of the business. Utility bills, phone bills, rent and other regular financial obligations are important factors of a business. Those will not function when the bills are not settled. So when bills are paid on time, that means the company is in great financial health.
Sufficient Liquid Savings
In life, there will always be unexpected events that we don’t have control over. We may experience some force majeure that will lead us to halt production or cease services. Or something might happen to production units that could possibly halt business activities. How much liquid savings do you have? If the company has to temporarily shut down for whatever reasons (highly hypothetical), how long will it survive with just one’s liquidity? Now that is one way to measure a business’s financial health.
Long-term Savings or Assets
Similar to the above-mentioned liquid savings, the amount of long-term savings or assets that you have is a large indicator of financial health. Just how long are you going to survive in just your savings or assets? The answer to that is a measure of your financial health. And in this indicator, the sufficiency of funds covers retirement of employees and other long-term employer obligations.
Sustainable Debt Load
If you have a manageable debt load every month, then it means that you are in good financial health. This means that majority of your income will not go to debt servicing. The problem with having a high debt load is that when there are emergency incidents, the debt servicing may be sacrificed in order to financially take care of the emergency. And if debts are paid late, a penalty will be added to the amount owed, which only makes it more insurmountable. The measure of a good debt load is less than 36% of the total expenses.
Great Credit Score
You don’t necessarily need to know how high your credit score is from each supplier you have. As a business owner or manager, you know if your credit standing is high or not because you are the one managing the payments. Of course, having a prime credit score means the business’s credits are settled properly on time and with more than just the right amount.
Of course, if you have managed to enroll the business in the different insurance policies, then it means that not only is your company a great employer, it is also in tip-top financial health. Incidentally, health insurance is the most important benefit employees could ever have.
The ability to foresee future expenses means you have enough financial leeway to plan ahead. This does not only give you financially healthy vibes, it also allows you to be more innovative. If you have the ability to think of future expenses, then this could be put into motion so that your company is always ahead of the game.
Every business owner and manager should be able to measure the business’s financial health every now and then. This will keep people in the business on their toes. And if you happen to be in great financial health, then it would be to your advantage to pat employees’ in the back. This will give them a morale boost to continue to perform better to keep the company in tip-top shape.