The available working capital of a business provides a measure of its short-term financial standing. When faced with a shortage of working capital, enterprises often opt for working capital loans to fulfil this inadequacy. However, lending institutions scrutinise a business’s financial health before they extend financing of this sort.
It is, therefore, crucial that business owners have a clear picture of their organisation’s financial position. But how can you measure the financial health of your business? Read on to find out.
Financial Analysis Of A Company
A business can examine several metrics to evaluate its financial status. Some of those are mentioned below:
Analyse The Balance Sheet
It offers an overview of a company’s assets, liabilities, and owner’s equity over an accounting period. Therefore, a balance sheet indicates a firm’s financial position at any specific point.
Here, assets refer to resources that a business owns. Liabilities include anything that such business owes. Additionally, the owner’s equity signifies the capital invested by a company’s stakeholders.
Furthermore, assets must always equal the sum of the owner’s equity and liabilities. This relationship is the basis of the accounting equation, which is calculated as below:
|The Accounting Equation|
|Assets = Liabilities + Owner’s Equity|
A balance sheet, therefore, helps one analyse the following:
- A company’s debt in relation to the equity capital
- The liquidity of a business in the short-term, i.e., less than a year
- Its ability to meet unforeseen expenses or undertake expansion projects
- Business growth by way of comparing balance sheets over subsequent financial years
Examine The Income Statement
It represents a company’s monetary position and overall profitability. A P/L statement denotes the revenues, expenditures, and profits of an organisation. Moreover, businesspersons can use an income statement to gauge their firm’s efficiency to translate its expenses into revenues.
It provides the following insights into a company’s finances:
- Increase in revenue over specific periods
- The gross profit margin
- The revenue percentage equivalent to net profit
- An enterprise’s ability to cover interest payments
- Identification of large expenses and how to curb them
Financial Ratio Evaluation
These ratios establish relationships between different financial pieces of information. As a result, they allow one to perform quantitative analyses and comparisons. Financial ratios are grouped into several categories, some of which are as below:
|Current ratio||Current Assets/Current Liabilities||A firm’s ability to meet short-term obligations|
|Quick ratio||(Current Assets – Inventory)/Current Liabilities||A company’s ability to meet short-term obligations using only highly liquid assets|
|Debt-to-equity ratio||Total Liabilities/Total shareholders’ equity||Percentage of debt versus its equity|
|Inventory turnover||Cost of Goods Sold (COGS)/Average Inventory||Firm’s efficiency in managing its stock|
|Total asset turnover ratio||Net Sales/Average Total Assets||Determines a firm’s ability to generate revenues from total assets.|
Analyse The Cash Flow Statement
A cash flow statement offers detailed information on a company’s cash utilisation. This statement shows cash flow sources and various areas wherein this cash was spent. Further, these areas are categorised into operations, investments, and financing activities.
A balance sheet and income statement are based on accrual accounting. As a result, they might not match an enterprise’s cash movements. However, cash flow statements effectively eliminate the effect of non-cash transactions. Thus, they offer more clarity on business finances to an owner.
It helps an individual to analyse the following aspects of his/her company:
- Liquidity of the business
- Sources of cash in the enterprise
- The free cash flow generated by a company to further invest in operations or assets
- Increase or decrease in overall cash
Therefore, an enterprise can measure its financial condition by a thorough evaluation of these factors. Routine analyses of these statements help companies determine cash flow gaps timely. To plug such gaps, one can avail working capital loans.
Alternatively, business owners can opt for more straightforward and quicker financing sources, such as invoice discounting. Through this financing solution, a business can use its cash tied-up in unpaid invoices. Thus, essentially, an enterprise does not need to take an additional debt. Instead, it allows companies to release future payments in advance.
In today’s competitive economy, finance’s importance lies in its capacity to keep a business afloat. Enterprises need a strong financial foothold to operate, sustain, and grow in the market. Therefore, organisational leaders must possess a thorough understanding of all financial records maintained by their firm. By being on top of their finances, organisations can identify the right moment when additional funds need to be injected. Moreover, they can obtain working capital loans or any other financing methods accordingly to avoid unnecessary hassle.