How to Know If Your Business Is Financially Healthy | CFOShare (2024)

Understanding Small Business Financial Health

Good financial health is when a business maintains stability, solvency, and the potential for growth. It reflects how well the organization manages its assets, meets its liabilities, and generates sustainable profits. Business financial indicators driving financial health include:

• Liquidity ratios (understanding cash flow)
• Solvency (asset, liability, and debt management)
• Profitability (gross margin, EBITDA margin, and net margin)
• Operational efficiency (ROA, revenue per employee, MRR)

A keen understanding of these business financial indicators allows businesses to navigate challenges, capitalize on opportunities, and ensure long-term viability.

How do you know if your business is financially healthy?

Use these direct indicators to determine if your business is financially healthy:

• Liquidity ratios of at least 1:1 show you can cover short-term obligations.
• A debt-to-equity ratio less than 5:1 to demonstrate your capacity to meet long-term debts.
• Consistent or growing EBITDA margins, signifying operational efficiency.
• Cash flow statements should consistently be in the positive.

Of course, there are reasonable exceptions to each of these basic standards. Check out our article on interpreting income statements and cash flows for a more detailed guide.

Signs of Financial Distress

Every business will face challenges, but persistent issues can be indicators of deeper financial troubles.

• Inconsistent cash flow means you’re unable to predict or manage the money coming in and going out, leading to potential solvency issues. Perform a cash flow analysis to determine the source of the variability.
• Increasing debt to revenue ratio may indicate an unsustainable reliance on borrowed funds. Work with your CFO on capital planning to ensure you do not become over-leveraged.
• Declining sales over multiple periods signal a potential decrease in market demand or competitive strength. Coordinate with your sales and marketing teams to turn trends back towards growth.
• Rising operating costs without a corresponding increase in revenue can erode profit margins, jeopardizing your business’s long-term viability. Examine your pricing strategy, revisit supplier contracts, and brainstorm efficiency investments to help cost management

Recognizing these signs early can be the key to implementing corrective measures.

Steps to Ensure Financial Stability

To safeguard your business’s financial future, proactive measures are paramount.

1. Check all financial ratios monthly and key ratios weekly. Just as you’d get a regular health check-up, your business requires routine financial audits to spot potential issues before they escalate.
2. Focus on profitability. Revenue trends are important, but only profit grants your business true freedom. Focus on strategies that increase revenues while maintaining or decreasing expenses. This might involve introducing higher-margin products or services, renegotiating supplier contracts, or optimizing operational processes to reduce wastage.
3. Never underestimate the value of expert advice. An external financial consultant can offer fresh perspectives, pinpoint areas of improvement, and guide your business towards sustained profitability.

These steps, when consistently implemented, can protect your business against unforeseen financial challenges.

Conclusion

In the dynamic landscape of business, ensuring financial stability is not just an objective but a necessity. Recognizing the signs of financial distress and proactively taking steps towards stability can set your venture on a path of sustained success.

Looking for a partner in the journey towards financial health? Schedule a consultation with our team to see if we are a good fit.

This article was written by a CFOshare employee with assistance from generative AI for rhetoric, grammar, and editing. The ideas presented are a combination of the author’s expertise, original ideas, and industry best practices.