Whether you’re an owner, investor, or just someone with a stake in a company’s future, understanding how to measure the financial health of your business is essential. It’s like checking the pulse of a company—making sure it’s thriving and on the right track. But how do you go about it? This blog post can help you assess the financial well-being of any business, in a way that’s easy to digest.
1. Cash Flow: The Lifeblood of the Business
At Cooper Norman, we understand that managing cash flow is critical for the long-term success of your business. Consider cash flow the heartbeat of a company. If money is constantly flowing in and out at a healthy pace, things are usually in good shape. But if cash is consistently tight, even profitable businesses can run into trouble. The key is having enough cash to cover daily operations and expenses.
Start by checking the cash flow statement. This will show how much cash is coming in (from sales, investments, or loans) and going out (through expenses like salaries, rent, and supplies). A positive cash flow means the business has more coming in than going out, which is always a good sign!
2. Profitability: Is the Business Making Money?
The next thing to look at is whether the business is profitable. This means that after all expenses, there’s money left over. You’ll want to check the income statement, which breaks down the company’s revenue (income) and expenses (like rent, payroll, and taxes).
There are two key figures to pay attention to:
- Gross Profit: This is what’s left after subtracting the cost of goods sold from revenue. It demonstrates how effectively a business is generating its products or services.
- Net Profit: This is what’s left after all expenses. A positive net profit means the business is making money. If it’s negative, that’s a red flag.
3. Debt: Is It Manageable?
Debt isn’t necessarily a bad thing—it can help a business grow. However, too much debt can become overwhelming and signal financial trouble. The key is to make sure that debt is manageable.
To get a sense of this, look at the debt-to-equity ratio. This compares the company’s total debt to its equity (the value of the business if all debts were paid). A lower ratio is generally better because it means the company isn’t overly reliant on borrowed money.
4. Liquidity: Can the Business Pay Its Bills?
Liquidity measures how easily a business can meet its short-term obligations—things like paying suppliers, employees, or utility bills. You want to make sure the business has enough assets (like cash or things that can be quickly sold) to cover its liabilities.
A quick way to check this is with the current ratio, which compares a company’s current assets to its current liabilities. A ratio of 1 or higher means the company can cover its bills, which is a good sign.
5. Growth: Is the Business Expanding?
Finally, look at whether the business is growing. Consistent growth is a positive indicator of financial health. This can be seen in increasing revenues, expanding customer bases, or larger profit margins.
Look at past financial reports to see if revenue and profits have been steadily increasing over time. If they’re growing, it shows the business is on the right path.
Conclusion
Measuring the financial health of a business might sound complex, but by focusing on these five key areas—cash flow, profitability, debt, liquidity, and growth—you’ll get a clear picture of how a business is really doing. Keep it simple, follow the numbers, and you’ll be well-equipped to make informed decisions.
If you’re ever unsure or need help diving deeper into the financials, Cooper Norman is here to guide you through every step!