A financially healthy business is always in the black. It makes payroll on time, and the employees are always satisfied. It also clears bills and other business expenses on time and has enough cash flow for inventory.
But it can be daunting to tell if a business is doing well financially on the surface. This is why you must employ tactics and metrics to evaluate a business’s financial health.
This guide details how to know if a business is financially healthy. We got you if you’re wondering how to go about it.
So, let’s get to it!
What is a Financially Healthy Business?
What is a financially healthy business? Simply put, a financially healthy business is profitable and can stress-free meet its financial obligations in the short and long term.
A financially healthy business is often liquid and has enough cash and assets, easily convertible to cash, to fulfil short-term obligations.
It’s also solvent and can meet its debt obligations continuingly, not only in the short term. A solvent business has enough assets outnumbering liabilities.
A financially healthy business has high operational efficiency and is more profitable. It can generate more income and returns at lower costs.
Lastly, a financially healthy business is highly profitable and can sustain its operations in the long-term hassle free. Liquidity, solvency, and operational efficiency are critical for a financially healthy business. But, profitability is more crucial and holds more water.
How To Know If Your Business Is Financially Healthy
Now that you know what metrics to look for when determining a business’s financial health, it’s best to understand how to evaluate them. Below are the things to check to know if a business is financially healthy!
1. Know Your Numbers
“Women lie, men lie, but numbers don’t lie!” Knowing your numbers in business is critical because it can either break or make the business.
Your financial books and records determine your business health since it’s a detailed accounts of your income and expenses. Your business numbers entail;
Numbers are a business’s backbone and knowing them sets you up for success. So, you want to know them like the back of your hands. This way, it’s easy to chat the way forward for the business by making the right calls.
The concept of business numbers is broad, and managing every aspect of it can be daunting. This is why you need a comprehensive bookkeeping plan to keep track of your business numbers.
2. Track Key Financial Ratios
A financial ratio is a quantitative tool to gain valuable insights into your business’s financial standing. Financial Ratios involve comparing and analysing two numerical values from your business’s financial statement.
You can use plenty of financial ratios to analyse your business’s financial health. The primary ones include liquidity, solvency, profitability, management, and balance sheet ratios.
- The solvency ratio–is also known as the debt management ratio. It shows how your business can meet its debt obligations from other sources. The total debt ratio and the debt-to-equity ratio are the primary solvency ratios. The total debt ratio is calculated as total liabilities/total assets, while the debt-to-equity ratio is calculated as total liabilities/total assets-total liabilities.
- The profitability ratio– measures a business’s performance by summing up the impact of its liquidity, asset, and debt management. Net profit margin (net income/sales), return on total assets (ROA) (net income/sales), basic earning power (BEP) (EBIT/total assets), and return on equity (ROE) (net income/common equity) are the primary profitability ratios.
- The management ratio–monitors how effectively a business manages its working capital. It measures how fast you replace stock, collect the outstanding debt from customers, and pay suppliers. The management ratio data is critical for improving a business’s performance. You can compare it with your competitors’ to make informed business decisions.
- The balance sheet ratio–comprises return on assets and investment ratios. It shows how effective your business’s investments are. Return on assets (net profit before tax x 100/total assets) is how efficiently your investment assets are generating profits. Return on investment (net profit before tax x 100/Equity), on the other hand, tells you if the effort you put into the business is worth it.
3. Stay On Top of Your Billing and Obligations
Consistency is vital when billing your customers and meeting your financial obligations. You need a regular cash flow to support your business operations.
So, you can’t afford to have a clot in the cash flow cycle. The way to do it is by staying on top of your billing game.
It’s crucial to prioritise paying your bills on time, whether it is one time or overhead costs, taxes, or supplier bills. A delay can affect the chain, and you don’t want it to come to that!
4. Set Aside Funds For Emergencies
Emergency funds go a long way during rainy days like the covid-19 pandemic that brought the world to a standstill.
Such surprises and economic shocks are guaranteed to come. The only businesses that sail through these storms have adequate funds for emergencies.
Financial experts recommend between three and six months of income saved for emergencies. But, the more funds you set aside for emergencies, the better. A financially healthy business should have at least 12 months of emergency savings.
5. Keep Personal and Business Expenses Separate
Business best practice is to separate personal and business expenses. This way, you can track business expenses and compare them with your business income.
A financially healthy business has an official business account. Managers draw funds from the business account to cover business expenses. This account isn’t for personal expenses since it’s hard to track expenses and keep records in order when there’s a mix-up.
Your financial reporting should be top-notch. But realising this can be daunting when you don’t separate personal and business expenses.
Analyse Your Business’ Financials and Identify Areas to Improve
Overall, a financially healthy business is profitable! Knowing if a business is financially healthy is a critical skill every business owner or key decision maker should have.
It starts by analysing financial statements and identifying areas to improve. It can also be daunting when you don’t know how to do it. Don’t sweat it because Visory has your back. Get Started with Visory Today!