What is Financial Health and How to Improve it For Your Company

In the balance of running a business, your company’s financial health may not be an obvious area for attention. However, it actually should be one of your most important priorities if you want your business to stand the test of time.

It is important for business owners and managers to understand what is financial health and the key elements that can improve it. By building a strong financial foundation, business owners and managers can increase their business’s competitiveness in the marketplace, while making sure they are better prepared to deal with future challenges.

Checking the financial health of your business.

What is financial health?

Like physical health, there are many factors that determine if your ‘body’ is endurable and able to withstand challenges. Investments, assets, liabilities, debt, and insurance — these are all measures that are taken into consideration when examining a company’s financial health and its sustainability in the long term. 

Financial health reflects a business’s potential for growth and longevity. With good financial health, you have the means to worry less about surviving in the present. Instead, you can have the confidence and stability to plan for the future. A good business skill to have is to be able to accurately determine your business’s financial health and take action accordingly. By being able to quickly adapt your operations to improve financial health, you are setting up your business for success in the long term. 

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How is a company’s financial health measured?

There are four key metrics that help determine your business’s financial health. While there are several factors that help evaluate the financial health of your company, the following four metrics are essential to examining a business’s sustainability and potential accurately. These measures can generally be found when analysing your financial statements.

Profitability

Profitability is one of the most critical measures of a business’s financial health. It is defined as a company’s ability to make and maintain profit. While businesses can be sustained purely through investment, profit needs to be made eventually otherwise they cannot survive.

There is often too much focus in a business on their ‘sales’ performance, but little understanding of what profit is generated, this can be measured by your net margin %. This is the ratio of net profits to total revenues. A business may be making millions of pounds every year, but if its net margin is only 1% or less then it is extremely unstable — one wrong expense and it could cost everything. On the other hand, a greater net margin implies greater financial safety as well as a stronger foundation for growth and expansion. 

Liquidity 

Liquidity refers to how easily assets can be converted into cash. It is key to measuring a company’s financial health, and how well it can counterbalance debt by meeting its short-term financial obligations 

Liquidity is measured through the current and the quick ratio. The current ratio is a ratio associated with liquidity that measures a company’s ability to pay short-term (within a year) obligations. The quick ratio is the same with the exception of inventory (as inventory often takes longer to convert into cash). The acid ratio gives a more conservative depiction of how well a business can handle short-term debt.  Industries can have different ratios, however generally a bad value would be lower than 1.0 as this shows obligations have exceeded current assets.

Solvency 

Solvency refers to a company’s ability to meet and handle financial obligations. Solvency differs from liquidity in that it not only measures the short-term but also how a business handles debt in the long term on an ongoing basis. 

Solvency is usually measured through the debt-to-equity ratio, this is a measurement that directly aligns long-term debt with current assets and equity. Interpreting this ratio can be tricky, especially as it differs between industries, but a low ratio generally indicates lower risk. This reflects a company funded more through equity rather than through loans, which is often favourable to lenders as debt in inherently risky and expensive, therefore . as a result, this is a measurement that your investors will be particularly interested in. 

Operating efficiency 

A business’s operating efficiency is the amount of profit that was gained after deducting operating costs. The higher its operating efficiency, the higher its profitability. This is because there is a greater potential for more income to be generated — without increasing operating costs. Broadly speaking it reflects how well management in a company can control its costs. 

Operating efficiency can be measured through the operating margin. This is the profit margin after operating costs have been deducted. This overlooks a range of costs including production as well as the marketing of the product/ service. 

Good operating efficiency also reflects good management and how well they can handle a variety of problems, particularly those that affect profit and loss. If management is capable of counterbalancing debt and allowing profit to continue driving upward, then it goes on to impact the company’s financial stability for good. 

Protecting the financial health of your business.

How can I improve the financial health of my business?

A well-run business is generally a healthy business. However, things can easily go under the radar and impact financial health later down the road. This is especially the case during expansion or business acquisition when your company is going through rapid growth. It is critical to hone in on these issues so it doesn’t impact the future. Luckily, there are a few solutions you can implement to ensure your business remains financially healthy and stable. 

Budget planning

There are many advantages to having a comprehensive budget plan. Establishing a clear and effective business budget is beneficial in that not only can your expenditure ahead, but you can also forecast the company’s earnings. Additionally, you can also hold yourself accountable as it ensures you can achieve goals and provide insight into spending reality. With a budget plan, you can validate every expensive made and shave off any unnecessary ones. 

A good budget plan will improve your financial health as it stops you from spending haphazardly. While it can help you with investing carefully, it also helps you gain investment too. When you’re looking to raise capital and search for funding, they will often ask for a detailed business plan, a properly planned budget reflects your commitment to growth and stability — a trait that is very appealing to potential investors. 

Professional support

Another way to boost your business’s financial health is by sourcing external support. If you reach out to a business accounting firm, a financial professional can utilise their knowledge and expertise to find practical ways to help your business get healthier. 

At Wilkinson Accounting Solutions, we use our arsenal of industrial know-how to not only oversee financial management but to also ensure your company is operating as smoothly and efficiently as possible. . To find out how we can improve your company’s financial health, get in touch with us today

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