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8 Questions to Check the Financial Health of a Company (and Ways to Improve It)

By Roy Rasmussen Reviewed By Erin Ryan
By Roy Rasmussen
By Roy Rasmussen Reviewed By Erin Ryan

The financial health of a company, by definition, refers to whether a business’s finances are balanced, taking into account 4 key components – profitability, liquidity, solvency and operating efficiency. Needless to say, knowing how to assess the financial health of a company is crucial for business owners. 

Here are 8 questions you can ask to gauge the financial position of your business. Plus, discover strategies you can use to improve your financial health.

1. How Strong Is Your Sales Revenue?

Sales are the lifeblood of any business. So when you’re asking yourself, “What is the best measure of a company’s financial health?” one of the first factors you should examine is sales performance. Sales revenue itself doesn’t directly indicate financial performance without additional information, such as how it compares with profit margins. However, revenue-related data underlies other important financial measures.

You can use a number of metrics and key performance indicators (KPIs) to measure sales performance:

  • Revenue: Income a business earns from sales of its products or services during a given period
  • Sales growth: Difference between your current month, quarter or annual revenue and the previous period’s revenue divided by the previous period’s revenue and multiplied by 100 to express a percentage
  • Volume of qualified leads generated
  • Lead conversion rate: Percentage of leads that convert to sales
  • Average value per transaction: How much you earn per sales, calculated by dividing the total value of transactions by the number of transactions
  • Customer lifetime value: How much money you can expect to earn from customers on average over the total time they’re engaged with your brand, calculated by multiplying the average transaction size by the number of transactions multiplied by the retention period 
  • Customer retention rate: Measure of repeat customers over a given period, calculated by subtracting the number of new customers from the total number of customers at the end of a time period, then dividing by the number of customers at the beginning of the period and converting the result into a percentage
  • Churn rate: Percentage of customers lost over a given time period, equivalent to the difference between 100% and customer retention rate
  • Prospecting actions per sales representative (such as phone calls or emails per representative)
  • Appointments set per representative
  • Conversion rate per representative
  • Sales generated per representative

Each of these metrics can give you insight into different aspects of your sales performance and their underlying causes. For instance, if you have low sales revenue coupled with a low volume of leads and prospecting activity, this may indicate that your marketing and sales teams need to take more lead-generating action to reach your sales targets, such as increasing your digital marketing activity.

A stethoscope is set around a small business.

2. What Is Your Gross Profit Margin?

Sales revenue has a strong correlation with your company’s financial health, but it doesn’t take into account how your income compares with your expenses. Without knowing this, you could have strong sales and still be underperforming because of high costs. To evaluate this, you can use profitability ratios, which are metrics comparing revenue with costs.

One of the most important profitability ratios is gross profit margin. This metric represents the profits left after factoring out the cost of goods sold (COGS), which refers to costs directly involved in production, such as materials and labor. It tells you how much revenue is left after paying for production to cover other costs such as administration and sales.

To calculate gross profit margin, take the difference between revenue and COGS. Divide the result by revenue and convert to a percentage. The higher your gross profit margin, the more of your earnings are available to cover non-production costs or generate profit.

  • Gross Profit Margin Formula

     

    Gross Profit Margin = Revenue – COGS / Revenue X 100

3. What Is Your Operating Margin?

Another important profitability ratio is operating margin. This measures how much you take in from sales after you pay for COGS, as well as operational costs and overhead. It is similar to gross profit margin, but the difference is that it takes these additional expenses into account as well as COGS. It tells you how much of your revenue is left over after covering the cost of production and operations to pay for nonoperational expenses, such as interest payments.

To calculate your operating margin, start by taking your operating income, also known as your earnings before income and taxes (EBIT), calculated by taking your revenue and subtracting COGS as well as operational expenses and overhead. Divide this number by your revenue and convert it to a percentage to obtain your operating margin. 

The higher your operating margin, the more of your revenue is left over after covering the cost of operations to pay for non-operational expenses or to generate profit.

  • Operating Margin Formula

     

    Operating Margin = Operating Income / Revenue X 100

4. What Is Your Net Profit Margin?

Another important profitability measure is your net profit margin, which directly relates to the net income appearing on your income statement. It represents the ratio between your net income and your revenue and tells you how much of your revenue translates into profit.

To calculate net profit margin, start by calculating your net income. You can find your net income by taking your total revenue and subtracting your total expenses. Divide the result by your revenue and convert it to a percentage. 

The higher your profit margin, the higher your company’s overall profitability.

  • Net Profit Margin Formula

     

    Net Profit Margin = Net Income / Revenue X 100

5. What Is Your Inventory Turnover Rate?

Inventory turnover ratio tells you how many times you’ve sold and restocked inventory during a given time frame. It can help you assess how much demand there is for your product, how much inventory you should keep on hand at a time and what price point you should use, all of which can affect your profit margins.

To calculate inventory turnover, you can use a number of formulas. The most accurate method is to take COGS for a given period and divide it by the average value of your inventory over that period before converting to a percentage. You can find average inventory by taking the value of your inventory at the beginning of the period plus that at the end and dividing the sum by 2. 

The higher the ratio, the more frequently you are selling and replacing your inventory.

  • Inventory Turnover Rate Formula

     

    Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

6. What Is Your Total-Debt-to-Total-Assets Ratio?

Another important category for evaluating the financial health of a company is to take a look at its solvency ratios, which measure your ability to meet your debt obligations over the long term. 

One major solvency KPI is your total-debts-to-total-assets ratio. This compares all the debt you owe in all categories, including short-term and long-term debts, to all your assets, including tangible and intangible assets. It tells how much of your assets are financed by debt rather than equity, which is a strong indicator of your ability to repay your debts. Investors consider the ratio of your debts to assets when deciding whether to invest in your company. The higher the ratio, the greater the degree of financial risk. 

To calculate your total-debts-to-total-assets ratio, add your short-term and long-term debt to get your total debt. Divide the result by total assets, including tangibles and intangibles, and convert the result to a percentage.

  • Debt-to-Asset Ratio Formula

     

    Debt-to-Asset-Ratio = Total Debts / Total Assets

7. How Is Your Free Cash Flow?

Another method for how to analyze the financial health of a company is to review its liquidity ratios. These measure your access to cash and assets that can easily be converted to cash in order to meet your short-term debts. Strong liquidity indicates that you have resources available to keep up with your debt obligations.

One common measure of cash flow is free cash flow (FCF). This measures how much cash you have available after paying for capital expenditures (CapEX), such as equipment payments and mortgage.

To calculate FCF, a common method is to start with your operating cash flow (OCF). This can be calculated by taking net income from your income statement, representing cash coming in, adding noncash expenses, (e.g., depreciation, investment gains, amortization) and subtracting your increase in working capital. 

After determining OCF, subtract CapEX, which will be listed on your balance sheet under a line item such as plant, property and equipment. The difference is your FCF.

  • Free Cash Flow Formula

     

    Free Cash Flow = Operating Cash Flow – Capital Expenditures

8. Do You Have Emergency Savings Reserves?

An emergency cash reserve can help keep your company financially healthy if your business or the economy suffers an unexpected downturn, such as the coronavirus pandemic. As the pandemic illustrates, having extra cash available can make the difference between surviving a cash-flow crunch and going out of business.

Most financial experts recommend having enough cash to cover 3-6 months of operating expenses, but this is a rule of thumb that may vary with the specifics of your situation. To make sure your cash needs are covered, complete financial projections for several years and check to see if your cash-flow projections indicate you will have sufficient cash available. If not, consider taking steps such as cutting costs, improving your marketing and sales strategy or applying for a business loan.

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What Can You Do If Your Business Is Struggling Financially?

The importance of the financial health of a company can’t be overlooked. After you’re able to understand how a company is doing financially, you can take steps to improve your financial planning and performance by boosting your key numbers. Here are core strategies for improving your financial performance.

Track Key Financials Consistently

Monitoring financial metrics, such as those mentioned above, can help you plan to avoid problems and alert you to emerging issues. Keep up with your key numbers by creating standard accounting and data syncing procedures to ensure your financial statements are updated. 

Use analytics tools to create automated dashboards and reports that highlight your most important KPIs. Establish a regular review process to ensure you’re staying on top of your financial performance.

Improve Your Marketing Strategy to Reach More Qualified Prospects

If you aren’t reaching your revenue targets, increasing your marketing outreach can bring more prospects into your sales funnel. 

Review your marketing message to make sure you’re emphasizing the right problems and benefits to reach your intended audience. Consider whether you’re using the best marketing channels to reach qualified prospects and whether you need to increase or improve your use of vital channels such as blogging, search engine optimization, social media and email marketing. 

Track and test the performance of your marketing campaigns so you know what’s working, what isn’t and how adjustments affect your results.

A small business rides an upward trend.

Improve Your Sales Strategy by Increasing Your Sales Conversion Rate

If you’re reaching prospects but failing to convert them into customers, improving your sales strategy to increase your conversion rate can increase your revenue. Review your sales procedures to make sure you have effective step-by-step processes for guiding prospects through your sales funnel to the point of transaction. 

Check your sales language to evaluate whether the problems, benefits and offers you emphasize are connecting with the needs of your prospects. Test different sales offers to see which one pulls the best results.

Improve Your Customer Retention Rate by Delivering Better Customer Service

A high customer turnover rate can cut into your revenue. Increase your profits by taking steps to improve your customer service for higher retention rates. 

Review your customer service performance and processes to identify any common complaints that could be avoided. Consider using automation or outsourcing to increase the efficiency of your customer service.

Increase Your Average Value Per Transaction

Your revenue directly reflects the average amount you’re earning per customer transaction. Increase your revenue per transaction to improve your financial performance. 

Test different price points to see if you’re selling at a lower price than your market is willing to pay. Use the sales and checkout process to offer customers other products that go with their purchase (cross-selling) or higher-priced alternatives (upselling).

Increase Your Customer Lifetime Value

Repeat business can multiply the value of each customer you gain. Develop strategies for extending sales offers to customers after their original purchase. 

Map out your customer’s lifetime journey and identify points in their experience where it makes sense to extend an additional offer. For instance, your newest product launch may appeal to customers who have previously purchased a specific product. Use incentives, such as loyalty discounts, to increase the appeal of your offers.

Reduce Payroll Costs

Along with increasing revenue, cutting costs can improve your financial performance. One of the biggest business expenses is typically payroll. Look for ways to cut your payroll costs. 

Automating routine tasks can increase the efficiency of your operations and reduce the number of labor hours you need. Outsourcing can also reduce your labor costs.

Reduce Inventory Costs

Inventory management can be another place to cut excess expenses. Using inventory management software can let you track and forecast supply-and-demand schedules more accurately. 

This in turn can allow you to employ inventory strategies that directly align supplier orders with production schedules (e.g. just-in-time method), reducing warehousing costs. Compare different shipping options to make sure you’re using the most cost-efficient method.

Look for Ways to Trim Your Taxes

A better tax strategy can save you money, which could be going toward covering your business costs. Talk with your tax professional about whether your present form of business organization is optimized for maximum tax savings. Make sure you’re tracking all your expenses and claiming all eligible tax deductions.

Cover Your Cash Flow

Cash-flow management forms a critical component of your company’s financial health. Keep your cash-flow projections up to date and review them regularly. 

Create an emergency cash fund to pre-empt potential disruptions. Additionally, optimize your business credit score so you can qualify for financing when you need it.

Consider whether you should apply for a business line of credit or short-term loan to sustain your company until you’re on better financial footing.

Monitor the Financial Health of Your Company to Maximize Profits

Using a company financial health checklist like the one presented here will help position you to identify any financial warning signs and take corrective measures before they escalate. This can help you maintain healthy profit margins and avoid cash-flow crunches.

If your company is facing an imminent financial emergency, consider seeking financing assistance. Read our blog to learn more about small business financing options, or fill out our no-obligation online application to find out the types of financing for which you may qualify.

Roy Rasmussen Contributing Writer for Fast Capital 360
Roy is a respected, published author on topics including business coaching, small business management and business automation as well as an expert business plan writer and strategist.
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