Financial Wellness Check

Financial Wellness Check: Assessing Your Business’ Stability

How do you know if your business is on firm financial footing? Financial wellness checks are just as important as annual wellness checks with your doctor. Simple indicators like cash from operations and debt service coverage ratio are early indicators of potentially larger business problems, just as blood pressure is an indicator of hypertension. You could go months or years without making such checks, but to do so is rolling the dice with your business’ health. 

By following a routine financial wellness check, you proactively detect risks and problems before they are catastrophic. 

How Do You Assess The Financial Stability Of A Company?

Just like a mechanic performs a 100-point inspection of your car every year, you should perform a financial health check of your business at least every quarter. The exact metrics to check will vary for every business based on your industry. However, there are four categories which should always be verified:

  1. Liquidity
  2. Profitability and efficiency
  3. Capital structure and obligations
  4. Growth 

Check out our sample general financial health check.

Liquidity Wellness Checks

Your business’ ability to generate positive cash flow is critical to stability. Positive cash flow businesses are the most stable, predictable businesses and are often independent of outside funding sources. Common liquidity checks include:

  • Cash runway – the number of months’ cash remaining. 12 months or more is ideal, while less than 3 months signals a liquidity crisis.
  • Current Ratio – the ratio of current assets to current liabilities. Anything greater than 1.0 is good.
  • Cash from operations – the amount of cash generated by the business independent of debt, equity investment, dividends, or long-term investments. This amount should be positive and stable.

The value of financial forecasts for business planning cannot be understated, and are an essential tool for calculating cash runway.

Profit & Efficiency Wellness Checks

A business’ long-term cash flow is largely determined by its profitability. A thoughtful review of certain metrics on the profit and loss statement will provide insight into business stability beyond the next couple months.

  • Operating Profit – commonly defined as EBITDA (net profit plus interest, income taxes, depreciation, and amortization) should be positive and stable from month-to-month.
  • Operating Margin – the ratio of your operating profit to net revenue. Anything less than a consistent 10% will create instability.
  • Gross Margin – the ratio of gross profit to net revenue. These vary widely by industry, but I have never seen a business succeed with gross margins less than 25% (except for Costco.)

Capital Financial Wellness Check

A solid capital structure is critical to a stable operation. Very healthy businesses have been killed by too much debt or toxic investor relations. 

  • Debt to equity ratio – the ratio of total debt to total equity should be less than 1.0 for maximum stability. Businesses may choose higher ratios to boost return on equity at the cost of more volatility.
  • Debt service coverage ratio – the ratio of operating profit over total debt payments (principle + interest) should generally be higher than 1.2. Many lenders require ratios higher than 1.3 or 1.4. Anything less than 1.2 leaves too little margin for error, income taxes, and other obligations which can create a debt default.

Growth Wellness Checks

In the face of constant inflation and competition, businesses must grow to maintain their profitability and returns. There are dozens of growth metrics for every industry, but a few universal wellness checks that work for most businesses.

  • Revenue growth – compared both month-over-month for non-seasonal businesses, and year-over-year for seasonal businesses. There should be at least 5%-20% growth each year to ensure financial stability. Excessive growth will destabilize a business too!
  • Profit variance – the difference between your actual profit and your budgeted profit.  Flat or positive variance is always preferred.
  • Cash variance – the difference between actual cash balance and budgeted cash balance. Again, positive variance is always preferred. 

Many businesses forget to budget their balance sheet, resulting in unfavorable cash variances. Check out our guide on how to create a business budget for more information.

How Do You Know If Your Business Is Financially Stable?

You should assess the financial stability of your business monthly or quarterly by performing a financial wellness check, like those in our financial wellness assessment.

Do not be discouraged if you score less than 100% – a perfect score is nearly impossible. Financial wellness planning begins by knowing your weak points, so use your “missed” metrics as insight into areas of risk and focus for your efforts. 

If you would like help creating a financial wellness assessment specifically for your business, reach out to our fractional CFO services for a free consultation.

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