Three Measurements of a Company’s Financial Health

Three Measurements of a Company’s Financial Health

We help a lot of different businesses setup and manage their financial reporting. The purpose of this reporting is to ensure that you’re on the right track, making progress, and financially healthy.

There are a lot metrics that help determine financial health in 10 to 15 different areas. For those of us who like numbers, it’s easy to head off into the financial weeds and get over complicated. The goal for this article is to simplify it down to 3 indicators that help manage profitability, cash-flow, and working capital.

  1. Revenues are Growing Faster than Expenses - this is a simple but powerful comparison. Make a spreadsheet. In one column, enter monthly revenue for the last two years. In the next column, enter total expenses for the same period. Setup a rolling 12 month average of revenues and expenses, then put these points on a graph. Are revenues rising or falling? Are expenses rising or falling in proportion to revenues? Healthy companies see rising revenues while expenses are flat or rising less then revenues. Falling revenues are an early indicator that expenses should be adjusted.
  2. Cash Balance Showing Positive Growth - again this is a simple report. On a spreadsheet enter month-end cash balances (from monthly balance sheets) for the last two years. Then create a rolling 12 month average. If you look at these points on a graph, or by inspection, is the average cash balance moving up or down? Heathy companies will see positive growth.
  3. Current Ratio Showing Positive Growth - this ratio shows the relationship between current assets and current liabilities. Again, take a spreadsheet, using data from monthly balance sheets, enter current assets in one column and current liability values in another for the last two years. Setup a rolling 12 month average of current assets and divided by rolling 12 month average current liabilities and put these points on a graph. Are you seeing the ratio go up or down? Healthy companies see assets growing faster than liabilities and the ratio is growing. The opposite trend indicates a possible problem with receivables or inventory.

With all 3 indictors above we suggest using 12 month rolling averages. The reason is to smooth out monthly variations and show a trend over a rolling one-year period.

While these are three simple reports that help measure financial temperature, we all know there is much more involved to running a business. However, if two or more of these indicators are showing negative trends there is a high probability a company is running into some serious financial health problems.

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