How to Check the Financial Health of a Company?
22

Feb 2021

A company is like a person. You have to take constant care of it otherwise there may be many problems to be faced. Just as a person needs to have health check-ups at the interval, the business should also have check-ups of determining the financial health if the business. Knowing about the financial health of the company is very important as this will allow the management to determine what business strategize it should implement to take the most advantage of the resources.

The easiest way of checking the health of the business is to Perform a Financial Analysis of the company. Let us first understand what is Financial Analysis and then we will look into what are the different steps which are to be followed to understand the financial health of the business.

What is Financial Analysis?

Financial Analysis can be understood as the examination and analysis of all the financial records of the company. All the transactions of the company are recorded which are later scrutinized to understand the financial condition of the business.

The financial analysis takes the help of the data to form various business-related ratios which help the management to understand the current scenario of the business. With the help of Financial Analysis, it is very easy for a business to understand and take action against any fraudulent activity or any loophole in the business.

Steps to Determine the Financial Health of a Company

There are many ratios which will help the management to understand the current financial standing of the business. The steps which will help to determine the financial health of the company are:

1.Preparation of Data

All the required financial data can be taken from the various reports which are being prepared during the Accounting process, namely Cash Flow Statement, Income Statement and Balance Sheet. Historical data of up to two years can be used during the process.

2.Profitability Score

This requires the calculation of the following ratios for the company:

  • Gross Margin
  • EBITDA Margin
  • Net Profit Margin
  • Return on Assets

Once the above ratios are calculated, a weight is assigned to each of the ratios and the score of each ratio is multiplied with the weight assigned to find out the profitability score.

3.Liquidity Score

These set of ratios help the management to understand the liquidity situation of the business. The ratios include:

  • Current Ratio
  • Quick Ratio
  • EBITDA / Interest Expense
  • CFO / Current Debt

The process similar to the profitability ratio is followed in which a weight is assigned to the ratios and then multiplied to find the Liquidity Ratio.

4.Cash Flow Score

To calculate the Cash Flow Score, we need to find the following ratios for the business:

  • Accounts Receivable Turnover
  • CFO / Current Liabilities
  • Discretionary Cash Flow

5.Leverage Score

  • Total Debt / Equity
  • Total Debt / Capital
  • Total Liabilities / Total Assets
  • Total Debt / EBTIDA

6.Aggregate Score

In this, we assign a weight to each of the broad categories of ratios which are:

  1. Profitability Score
  2.  Liquidity Score
  3. Cash Flow Score
  4. Leverage Score

The consolidated score of the company is calculated by making a sum product of the score and the weight assigned to it.

By finding out the above-mentioned ratios, the management of a company can easily find out the financial standing of the business. Finding out these ratios are important as these not only provide a clear picture of the financial health of a business but will also help the investors to make an informed decision about investing in the company.

Though it should be made sure that the financial analysis of the company is being performed by an expert or else the data collected will be wrong which will influence the company in the wrong way. If you want to conduct the financial analysis of the company in the United Arab Emirates, then you can utilize the services of JAXA Chartered Accountants. JAXA is a professional firm and the panel of experts will understand the requirements of your business and perform the financial analysis accordingly so that the company faces no problem.

For more details on the services provided by JAXA Chartered Accountants, Contact Us. We will be happy to assist you and your company.