Every company, business, or organization is organized differently. That’s why determining a particular organization’s financial status is not just a checklist with boxes that you can tick off.
However, several standards and metrics can be used to accurately review a company’s overall performance and financial health. This data can help to determine the likelihood of the company’s survival. There is no single number or parameter that we can use to achieve this – all financial metrics must be considered in tandem.
The main factor to determine a company’s health, is profitability. We can also examine liquidity, solvency, and operating efficiency to get a clearer picture and plot a course for the company’s future.
Let’s learn more about each factor below.
Liquidity pertains to the cash the company owns, plus the assets that can be easily liquidated, or converted into cash. This typically enables the company to manage short-term debt obligations. Before it can eventually prosper, a company should be able to weather and survive within a short-term period.
To measure liquidity, one needs to look at quick ratio.
The conservative measure is known as the quick ratio, which is also referred to as the “acid test.” This metric excludes inventory and prepaids from current assets and long-term debt incurred from various liabilities. This makes it a more practical indicator of how well a company can manage short-term obligations with their existing assets.
To compute the quick ratio, use the following formula:
QR = (Current Assets – Inventories – Prepaids) / Current Liabilities.
If your company’s quick ratio falls lower than 1.0, that may be a warning sign, as your current liabilities are already exceeding your most liquid assets.
Liquidity is a company’s capability to manage short-term obligations, and solvency is its ability to meet debt obligations on a regular, ongoing basis.A company’s solvency can project if a company’s cash flow is sufficient to meet its long-term debt obligations. One of the main solvency rations is the debt-to-equity ratio, abbreviated as D/E ratio. Finding out your D/E ratio serves as an exact indicator of your company’s long-term sustainability, as it gives owners an idea of how much debt is stacked against equity. This can also be a sign of an investor’s interest and confidence in a company since if a company’s D/E ratio is high, it leads to high interest rates which adds an additional level of difficulty to stay afloat.
Your debt-to-equity ratio can vary from one industry to another, but regardless of your business and the landscape you work in, you should aim for a downward trend over time. This is a good sign that your company is on solid financial ground.
To calculate this ratio, divide your outstanding debt by your equity.
This is one of the keys to your financial success.
Your operating efficiency will be one of the best indicators of your financial stability and, as the name suggests, your efficiency. It indicates how well the company manages its costs. Proper management is essential for a company’s sustainability. Keeping tabs on operating efficiency can also help in addressing potential future problems. On the other hand, bad management can lead the company to collapse.
While there is no reliable, technical way to measure a company’s operational efficiency, you can roughly arrive at tangible data by calculating the ratio of output gained to the input spent. You can factor in your operational expenditure and capital expenditure here, as well as quantify human resources, customer satisfaction, and revenue. These, of course, will vary from one business to another.
OR Reporting can help you figure out your operational efficiency with its wide array of services that help you extract data from your operations and put it all to beneficial use. OR Reporting can also build daily and weekly business intelligence dashboards to help you track your operational efficiency through any device.
At the bottom line… is the bottom line.
While all the factors mentioned above are crucial, your net profitability will decide how your company will thrive in the future. You can only go so far on just the goodwill of your investors – you need to turn a profit!
To evaluate your profitability, you’ll need to calculate your net margin, which is the ratio of net profits divided by your gross revenues.
This is a crucial step to gauge your financial health. You may have a net profit of millions of dollars, but that figure may yield a net margin of only 1% or less. In this situation, a slight increase in operational costs or competition, may put your company below the line.
With a sizeable net profit margin, you have a great “buffer zone” for financial security while also showing that the business is doing well – allowing for huge steps such as committing to expansion.
There is no single dependable method, process, or model to figure out a business’s financial health. It will vary from company to company and from one industry to another.
However, there are always four factors you need to consider when checking on your company’s financial health: liquidity, solvency, operating efficiency, and profitability. Check all these factors regularly before making huge steps for your company.
If you need help figuring out and understanding the state of your financial affairs, OR Reporting offers cost-effective and straightforward access to accounting and finance assistance without the price tag of developing your own in-house team. Corporations and small businesses can select the business accounting services that suit their requirements, or we can work together to figure out the best way forward.