As a business owner, manager, or entrepreneur, you must know how your company performs financially. Knowing this will help you know the kind of projects and initiatives to take up per time. If you want to grow your company, making informed decisions is crucial, and you can’t make informed decisions without understanding the financial health of your business.

In this article, we will take you through the SMEs financial health checklist, which will guide you on how to check the financial health of your business at any time.

What is a Financial Health Checkup?

A financial health checkup comprehensively analyzes your business’s financial management processes, practices, and performance metrics. It can also be seen as profoundly evaluating your financial situation, including budgeting, debts, savings, investments, and future goals.

This helps you to identify areas of your business’s financial strength and weakness, which guides you when making critical decisions regarding the financial health or progress of the company. Additionally, it can serve as a diagnostic tool to test the effectiveness of the financial systems in the company to ensure they are efficient, effective, and aligned with the organization’s strategic objectives.

Simply, the primary goal of conducting financial health checks in your company is to ensure that the business’s financial operations align with the business goals, support its growth objectives, enhance operational efficiency, and safeguard the organization’s assets. If, after analysis, your financial results don’t support any of these, it is a clear indication of a problem.

Understanding Critical Financial Ratios

To conduct a financial health checkup on your business, there are critical financial ratios you must familiarize yourself with. These ratios help you evaluate and interpret the company’s financial performance. Below are the four main critical financial ratios to consider:

1.      Liquidity Ratios

This is the specific ratio type used to ensure the company’s ability to cover up its short-term debt obligations. It consists of current and quick ratios. The current ratio measures the ability to cover short-term obligations with current assets. The quick ratio also assesses the ability of the company to pay its short-term obligations without selling inventory.

2.      Profitability Ratios

Profitability ratios are financial metrics used to assess the company’s ability to generate profit relative to its equity, revenue, balance sheet assets, and operating costs during a specific period. It consists of Gross Profit Margin and Net Profit Margin. The Gross Profit Margin shows the percentage of revenue that exceeds the cost of goods sold (COGS). In contrast, the Net Profit Margin shows the rate of profit generated when expenses are deducted from total revenue.

3.      Solvency Ratios

This ratio examines the company’s ability to meet term debts and obligations. Solvency ratios include the Debt-to-Equity Ratio and Interest Coverage Ratio. The former assesses the proportion of debt and equity used to finance the company’s assets, while the latter evaluates the company’s ability to pay interest on outstanding debt.

4.      Efficiency Ratios

Efficiency ratios help to illustrate the company’s ability to generate income using its assets. Inventory. A significant type of efficiency ratio is the inventory turnover ratio, which assesses how often inventory is sold and replaced over a period of time. On the other hand, Accounts Receivable Turnover measures how efficiently a company collects its receivables.

How Do You Measure the Financial Health of a Small Business?

Here are the key steps to measure your small business’s financial health. Conducting comprehensive checks on these metrics will give you a comprehensive overview of the financial health of your business.

1.      Conduct a Financial Statement Analysis:

The first step in assessing the financial health of your business is to conduct a comprehensive financial statement analysis of the three primary financial statements: the income statement, balance sheet, and cash flow statement.

The income statement contains details of your revenue, expenses, and net income over a specific period, which gives you insight into the profitability level of your business. The balance sheet presents an overview of the company’s financial position at a given time, showing its assets, liabilities, and equity, which provides you with an understanding of the liquidity and solvency of the business within a specific time.

The cash flow statement states how cash is generated and utilized in operating, investing, and financing activities, giving you an overview of the business’s ability to meet its short-term obligations. By comparing these statements, you understand the financial stand of your business within a specific time.

2.      Calculate Key Financial Ratios

Once the financial statements have been analyzed, the next step is calculating vital financial ratios. These ratios are critical indicators of a business’s performance and financial stability. Calculating these ratios helps you to identify areas of strength or weakness that are important in making strategic and critical financial decisions for the company.

3.      Monitor Cash Flow

Another essential aspect of measuring your business’s financial health is monitoring your cash flow. Cash flow statements offer a detailed analysis of the inflows and outflows of cash. Analysis of the cash inflow and outflow patterns helps you identify potential liquidity issues in advance and take corrective actions to secure the business’s financial health.

4.      Review Budgeting and Forecasting Processes

Effective budgeting and forecasting are crucial for maintaining financial health. By assessing how well the business plans its finances through budgeting, you can allocate resources efficiently and prepare for future expenses. A well-structured budget provides a roadmap for financial decision-making and helps identify areas where costs can be controlled or reduced. Also, forecasts help to enhance your future budgeting efforts by providing relevant data and information. You can make more informed decisions regarding budgeting when you understand the gaps between the projected and actual figures.

5.      Evaluate Asset Management

Analyzing how effectively your business utilizes its assets to generate revenue gives you insight into your business performance. Key metrics, such as return on assets (ROA) and asset turnover ratios, help you understand how well your business uses its assets to drive profitability, whether it is performing well or not.

By understanding critical financial ratios and implementing effective measurement strategies, you can identify if your company is financially stable, compliant, and positioned for future growth.

Final Words

Understanding the financial health of your business is not just beneficial; it’s essential for making informed decisions, seizing opportunities, and driving growth. At Mac Adebowale Professional Services, we understand SMEs’ unique challenges in today’s competitive landscape.

Schedule a consultation with our team of financial experts to conduct a comprehensive financial health checkup of your business or company. Contact us today at emails@macadebowale.com or macadebowaleadvisory@gmail.com, and let’s get started.