How to Determine the Financial Health Of A Company - Things to Consider

Vivien Thuri
This piece has been written in collaboration with Esther Friedberg Karp, an esteemed bookkeeper and QuickBooks ProAdvisor.

Financial health is a core part of every business, regardless of size. But, especially for small businesses looking to grow, understanding the financial health of a company is crucial.

A research report by the Federal Reserve Bank of Chicago has shown that small businesses that consistently monitor financial health are better placed to sustain current performance and continue to grow.¹

This article will take a deeper look at business financial health and why mapping it is so vital.

Table of contents

What is the financial health of a company?

Financial health for a business means that the overall financial state of that business is balanced. To look at financial health, the company should use different measures to give an overall picture.

The more knowledge a business has about financial planning and management practices, the more likely it is to be financially healthy - putting it in the best possible position for success.¹

Generally, when you are thinking about how to determine the financial health of a company, there are four key areas to look at:

Key areas to look at for financial healthDefinition
Liquidity Liquidity refers to how easy it is for businesses to convert their assets and/or securities into cash to meet its financial obligations if needed.²
Solvency Solvency is measured by looking at a company's assets versus its liabilities to understand whether a company can repay both its long-term and short-term financial obligations. ³
Profitability Profitability refers to whether the business can generate a profit, and is used as an indicator of how it will perform in the future. Profitability is calculated by subtracting a company’s net revenue from its expenses to identify its profit margin.²
Operating efficiency Operating efficiency looks at how well a business controls its operational costs. Operating efficiency is measured by the operational profit left after subtracting production and marketing costs associated with the company’s products or services.²

Businesses may also look at other areas to better evaluate financial health across different parts of the business.

A financially healthy business should be able to control and manage its operating efficiency, cash flow, solvency, and profitability. Wise Business can help you with money management, invoice payments, and more, especially if you have an international business operating in multiple countries.

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Why is the financial health of a company important?

So why is business financial health so crucial? In short, it’s the main factor for its success.

A financially healthy business has the potential to stay on the market and scale.

It provides a clear picture of where resources should be invested and where costs need to be cut based on current financial status.

Ultimately, the health of a company helps determine future strategy and growth. For example:

  • financial health can help you identify whether you can grow your team through outsourcing or hiring

  • where you can renegotiate contracts to get better deals

The financial health of a business can also help you identify whether it’s the right time to grow on an international level and identify other opportunities to expand the business.


Financial health for international companies

For international businesses, financial health plays a significant role.

There are multiple challenges associated with running a business in different locations that might be tough to identify otherwise. Determining a company’s financial health can provide more insight into:

  • how late payments, fees, and unexpected international costs impact assets and cash flow

  • identify ways to cut down on these costs

  • helps with creating expansion and growth strategies and

However, it’s crucial to remember that business financial health can vary based on a variety of factors such as how large the business is, how many full-time employees are on staff, debt obligations, and other influences.

That’s why monitoring financial health and undertaking different analyses to ensure you’re getting the whole picture is extremely important.


3 important practices to maintain a financially healthy business

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There are key practices that can help you maintain a financially healthy business.

Businesses that follow these practices tend to be in the best position for sustained growth and success.¹

By understanding the practices and how they connect, you can develop a financial performance strategy that works for your business and gives you a comprehensive insight into all aspects.


Financial knowledge

Businesses with deep financial knowledge about their own performances and available resources tend to have good financial health.¹

How to boost your financial knowledge

  • Monitor financial statements regularly, including cash flow, balance sheets, and income statements

  • Identify and avail financing opportunities such as asset-based financing, including working capital loans and term loans. With this type of financing, assets such as inventory, accounts receivable, trade, and equipment are used as collateral if the business cannot pay back the loan.

  • Look for business banking solutions and bookkeeping software to help you manage day-to-day finances.

💡 Not sure where to start? Learn with Money Smart for Small Business
MSSB gives you insight on topics such as starting and managing a business, developed by the Federal Deposit Insurance Corporation (FDIC) and the U.S. Small Business Administration (SBA).

Credit experience

Businesses that monitor and maintain financial health have an easier time obtaining business loans and credit cards.¹

The more businesses are able to demonstrate financial health, the easier it gets to secure funding from lenders and banks.

In addition, as businesses gain more credit experience, they can obtain more working capital to maintain operations and expand the business, leading to further success.

How to build and maintain your business credit⁴⁻⁵

  • Ask suppliers for credit terms to start building business credit
  • Make loan and bill payments on time
  • Keep outstanding balances low
  • Maintain a few different lines of credit
  • Monitor and review credit reports regularly

Financial planning and management practices

Financial planning and management is an essential component of running a business.

The financial health of a company is very much dependent on how it plans for its current operations and future growth.

However, financial planning is underpinned by effective cost management to ensure that businesses are meeting their goals.¹

How to practice financial planning and management¹:

  • Establishing and meeting a budget
  • Using a reasonable amount of credit with access to further credit lines
  • Maintaining full-time staff employment
  • Running payroll operations from a business account
  • Monitoring financial performance

5 signs that your business is financially healthy

piggy-bank-smiling-with-coins

1. Customers always pay on time

A strong business ensures that customers can pay on time, and the business has made the payment process as easy as possible.

Conversely, late customer payments and difficulties can negatively impact a company’s financial health in many ways.

It can become increasingly complex trying to figure out how to determine the financial health of the company if less revenue is collected.

That’s why it’s crucial to ensure customers pay on time, and they have options such as paying in their local currency or choosing from multiple payment options to simplify the process.

Offering customers options for how to pay and making these options virtually seamless and effortless will go a long way to speeding up customer payments.

Also, if these options are easy to offer customers, it means that businesses will be more open to selling their goods and services globally, increasing sales and the bottom line.

With the Wise multi-currency account you can ensure an easy solution for your overseas customers to pay you in 10 different currencies, just like they'd pay a local.

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For easier money management


2. Salaries are paid on time

Regular and consistent payroll operations are one of the most significant signs of whether a company is financially healthy.

Healthy businesses with excellent financial health can maintain employee salaries and benefits without disruption.

Moreover, owners should also be able to draw their salaries from the business rather than infusing the business with more cash to cover salaries.

If both employees and owners are consistently receiving salaries, it means the business has enough operational cash to sustain itself.

Esther, founder of EFK Compubooks in Toronto says

Image
    She has been named twice to the list of Insightful Accountant’s Top 10 QuickBooks ProAdvisors worldwide, with the titles “Top International ProAdvisor” and “Top Trainer/Writer ProAdvisor.”

Having the ability to pay employees easily in different currencies and with minimal bank fees means that your pool of talent is considerably larger than competitors who do not have this ability.

Since the talent pool is literally global, this means that you can likely find workers at a lower cost, thereby, in addition to minimal bank fees and preferential exchange rates, increasing your bottom line.


3. You are not behind on rent and utility payments

Financially healthy businesses, particularly international ones, need to be able to meet all their operational expenses.

When managing different office locations, it’s vital to keep track of utility payments, rent, and other office expenses and pay on time. Otherwise, late and overdue payments can negatively impact your business credit and financial performance.

Businesses that fall behind or are unable to keep up with payments are far less likely to be financially healthy, and in the long run may suffer financial damage.

Again, having the ability to pay utilities quickly and easily in different currencies helps expedite the payments and lower the risk of falling behind.


4. You don’t owe suppliers payment

As with rent and utilities, supplier payments can also be an indicator of business financial health.

Companies must pay suppliers on time, but it can get complicated - especially for businesses with multiple locations.

In addition, managing a large number of suppliers with differing payment terms can become complicated.

Plus, for suppliers abroad, payments may end up incurring extra charges and fees due to conversion rates, which can drive up costs.

Financially healthy businesses should be able to pay suppliers on time and find ways to cut down associated costs to improve their cash flow.

💡 Did you know?
Wise did some research, comparing their business prices to PayPal’s. The research was carried out between 6 Janaury 2021 and 14 January 2021.
  • When sending and receiving USD to EUR business payments, Wise Business is 12.2x cheaper than PayPal
  • When sending and receiving USD to GBP business payments, Wise Business is 11.9x cheaper than PayPal
  • When sending and receiving USD to AUD business payments, Wise Business is 10.9x cheaper than PayPal

5. You’ve accounted for currency risk

For businesses operating internationally, there is an added angle of risk that needs to be considered.

Business financial health can be impacted by currency risk, particularly during times of uncertainty and instability.

That can negatively influence revenue, cash flow and impact the company’s financial health.

To avoid high exchange rates and currency risk it's best to:

Other measures such as political risk insurance and using a regulated provider that safeguards your finances can also help.

Manage your payments without the hassle, and boost your business’s bottom line with Wise

Wise-business-account

Streamline the payment process, easily convert between currencies, manage subscriptions, and more. Using the Wise multi-currency account, businesses can gain more transparency and control on cash flow.

Get the mid-market rate for international transfers when sending payments to suppliers overseas and paying employees abroad.

Use the Wise currency exchange rate tracker, get alerts and send money when it’s best for you.

Additionally, businesses can receive payments like a local with account details - such as IBAN, routing number, Sort code, and more - in up to 10 currencies, making it easier to connect with customers and avoid late payments from abroad.

All of the above helps the business manage day-to-day finances, reconcile past business activities and plan better for the future.

Open your Wise business account today

Sources:

  1. Federal Reserve Bank of Chicago - Small Business Financial Health Analysis
  2. Investopedia - What Is the Best Measure of a Company's Financial Health?
  3. Corporate Finance Institute - Solvency
  4. Federal Deposit Insurance Corporation - Money Smart for Small Business
  5. U.S. Small Business Administration - How to Build Business Credit Quickly: 5 Simple Steps

All sources checked 11 November 2021


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