As a business owner or an entrepreneur, knowing the financial health of your company is not just a crucial business skill, but is important for various reasons. Your company’s financial health will help you make informed decisions regarding the future goals, resource allocation, investment and financing. This knowledge also enables you to become a manager who can better guide their team and motivate them to see the overall vision.
A clear understanding of the financial health of your company also helps you re-evaluate your investments and initiatives that have not incurred the expected return. Your company’s financial health is also a great indicator of the overall well-being of your company and its people. Employees get a sense of security and the understanding of asking for promotion at the right time when a company is doing financially well while on the other hand, when they see a company struggling, they will be planning to jump the ship.
So, how can you gauge the financial health of your company? In this blog, we’ll be talking about a few key indicators.
1. Liquidity
Evaluating your company’s liquidity is the easiest way to tell if your company is doing financially well or not. Liquidity is the amount of cash and easy-to-convert-to-cash assets your company holds to manage its short-term debt obligations. This is a huge indicator of whether your company can survive in the short term or not.
You can measure your company’s liquidity by assessing your current ratio and quick ratio. Of these, the quick ratio is a more viable indicator because it doesn’t include your inventory from assets as well as your long-term liabilities, making this process more realistic and practical to see if your company can survive in the short-term.
If your quick ratio is less than 1, consider it a warning sign.
2. Operating Efficiency
Your company’s operating efficiency is about how well it manages to control costs. You can understand this by analysing your company’s operating margin – this is your company’s basic operational profit margin after you subtract the cost of production & marketing.
Your company’s operating efficiency also depends a lot on management. A good management can help create long-term sustainability while fixing temporary problems.
3. Solvency
Solvency is very closely related to the first point in this blog i.e. liquidity. But while liquidity is about meeting short-term obligations, solvency is about the ability to meet maturing obligations as they come due. So, your company’s solvency ratio will help you understand its long-term debt in relation to assets or owner’s equity.
If your company’s debt-to-equity ratio is lower or has a downward trend, this is an indicator of a good financial health. It means your company’s operations are financed more by your stockholders than by your creditors, indicating a high confidence and investor interest in your company.
4. Profitability
Often dubbed as “bottom line”, your company’s net profit is the single best indicator of its financial health. While we’ve discussed other important factors in this list, your company’s net profitability indicates its long-term viability. It is possible for your company to survive for years without making profit – perhaps you have great goodwill of investors. However, to survive in the long term, your company needs to be build and maintain profitability.
Now, while evaluating the profitability factor, it is important to take into consideration the net margin. Your net margin is the ratio of net profit to total revenue. If you only focus on the net profit figure, you may be misevaluating the whole scenario. Net profit figure can give you a false idea of a huge profit, but even a slight increase in operation cost could give your company a huge shock if the net margin is only 1% or less.
A larger net margin means your company is financially sound and has a safety buffer from marketplace changes.
At BMC SAAS, we provide a 360-degree accounting service to ensure a solid financial ground to your company. BMC SAAS will be your reliable offshore team managing your accounting operations so you can focus on what you love.
To learn more about how BMC SAAS can help your business, contact us about your business’ requirements
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