No business can ignore or be nonchalant about its financial health and still survive. Financial health is critical, and moving forward successfully requires regularly and rigorously analyzing your business’s financial health.
What is Financial Health and Why is it Important
“Financial health” simply means the financial condition of a business. It includes the volume of money flowing into a business compared to the amount of money flowing out of the business, along with its liabilities and debts. These must be managed well to achieve a smoothly operating business that yields satisfactory profits. How well a company can control its capital to pay its expenses, make appropriate investments, and create profits is how financial health is measured. Analyzing your business’s financial health leads to business strength and progress.
Financial health is important because it affects the capacity of a business to manage its finances, survive, generate profits, and grow. A financially healthy business keeps stockholders happy, enables a company to get good purchasing terms, and makes a company attractive to banks and investors.
Analyzing your business’s health–four areas to focus on:
- Cash flow. How much cash is flowing into the business relative to the amount of cash flowing out?
- Earnings. How much money is left over after a company has paid its expenses?
- Equity. How much money is invested that is not guaranteed to be paid back?
- Debt. How much money is owed? Debt is commonly used to finance a company’s operations but if there is insufficient cash flow to pay back the debt, the company can be in trouble.
Importance of Financial Statements for Analyzing Your Business’s Financial Health
Financial statements are the critical financial records that report a company’s financial performance and business activity. They provide a snapshot of a business’s condition at a point in time. They provide critical information and insights into a company’s financial position, profitability, and growth potential. They are also used to flag financial problems or accounting improprieties.
Financial Statement Analysis for Analyzing Your Business’s Financial Health
There are three statements used to determine your business’s financial health.
The balance sheet. The balance sheet reports a company’s assets, liabilities, and shareholder equity. Short-term assets including cash and accounts receivable are indicators of a company’s operating efficiency. Liabilities include a company’s expense payment arrangements and its payoffs of current debt. Shareholder equity includes details of a business’s equity investments and retained earnings.
The income statement. The income statement reports the income that a company earns compared to its expenses to render a net profit or loss. In three parts, the income statement reports gross profit, operating profit, and net income.
The cash flow statement. The cash flow statement provides a picture of a company’s cash flows from its operations, investment activities, and financing actions. A company without current cash can’t operate.
These three financial statements can be analyzed in three ways. First, horizontally comparing historical data to understand trends. Second, vertically comparing items on the financial statement to each other. Third, ratio analysis, including gross profit margin, net profit margin, coverage ratio, current ratio, quick ratio, debt-to-equity ratio, inventory turnover, and total asset turnover.
A qualified CPA can provide highly useful expertise in interpreting and utilizing financial reports to better understand and manage your business.
Ways to Keep Your Business Healthy
In addition to analyzing your business health by effective use of financial statements, consider these useful tips:
- Always keep your business and personal finances separate.
- Utilize small business loans wisely to give you the funds needed to purchase valuable equipment, additional inventory, real estate, or other things to help your business grow.
- Make sure you have an emergency fund.
- Keep a line (or lines) of credit open.
- Constantly work on improving operating efficiencies.
- Always pay your debts and taxes on time.
Get Expert Accounting and Financial Assistance
Contact Doerhoff & Associates, CPA, based in Jefferson City, MO for professional accounting and financial assistance that you can count on. Doerhoff & Associates has one goal in mind, to provide comprehensive business accounting services designed specifically for your success.