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Financial health: what to monitor

17/02/2021
Author Avatar
Stijn Boonen
Sales Engineer, EASI

Some companies are financially healthy, but may still face problems in the short term. I'll explain what to monitor.

The basics

In general, there are 3 key indicators of financial health. It is, therefore, important to review how you systematically report on:

  • Solvency, or the ratio of equity contributed by shareholders to equity contributed by third parties. A healthy company is not only dependent on lenders, it must also show sufficient equity on its balance sheet. That is why this indicator is mainly used to measure how healthy the company is in the longer term. It also indicates, for example, whether you have sufficient capital to take advantage of new opportunities.


  • Liquidity, or the ability of your company to meet its current financial obligations and short-term debts. It is calculated by subtracting the stocks from your current assets and dividing that amount by your debts over one year. This mainly is an indicator of the short-term financial health of your company.


  • Profitability is the indicator that shows exactly how profitable your business is. Calculate it by dividing the net profit by the equity capital and multiplying the outcome by 100. It goes without saying: the higher the percentage, the more profitable the company is.

Surplus


And yet there are other important indicators that show the state of your business. It is very important to consider how they can be ‘measured’ and how you report on them. Factors to take into consideration are, among other things:

  • How satisfied are your customers?
  • How qualitative is the work performance of your staff members?
  • How sustainable is the relationship with your suppliers?
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Under the radar?

But... if a company gets into trouble, it is not always because they did not follow up on the indicators I have mentioned above. Sometimes red flags are overlooked. Prevent your company from getting into difficulties and pay extra attention to the issues listed below.

  • How does your company deal with audits?

Auditors and executives or management may have different opinions about the outcome of an audit. Auditors often have a more conservative view of the results. About identifying potential loss items, for example. An auditor also typically presents a “summary of misstatements”. In it, they record the errors made, which were corrected and which were not. Make sure to thoroughly review such documents in order to avoid differences of opinion leading to errors or inaccuracies in your company's financial reports.

  • How about cash flow?

This indicator is a very important warning sign for problems. When can you expect to have a negative cash flow? Profit becomes positive when you send an invoice, but your cash flow becomes positive only when an invoice is actually paid. In other words, you can temporarily make a profit when you have already invoiced your customers for a large part of your business, but when those customers have only paid a small number of those invoices, you end up with a negative cash flow. If this situation continues for too long, you are in trouble. You will notice the consequences of a negative cash flow when you calculate your liquidity. Is it too tight? Ensure to communicate with your customers, partners and suppliers in order to work towards a healthier situation for your company.

  • How about customer portfolio diversity?

Smart savers do not put all their eggs in one basket. Spreading risks is smart, but so is spreading opportunities. Protect yourself by avoiding dependence on one or a few customers in the same segment, because a certain sector may face problems, or one of your customers may be declared bankrupt. Variety is key – and we mean that in the broadest sense – so look for variation in both customer type and, for example, their locations.

  • Do you focus exclusively on turnover instead of profit?

Although your turnover can increase significantly, this may not always be reflected in your profits. If that is the case, it pays to look at how your overheads or operating costs have evolved. As an indication, try to mainly focus on what you have actually earned and focus on structural profit and a profitable business model.

  • How do you deal with irregularities and complex data?

Are figures higher or lower than expected? Do you investigate what causes it? Are the monthly closings performed correctly, are operating costs being capitalized, or what causes an increase in ‘other expenses’ or ‘legal costs ‘, for example. It is good practice to investigate unexpectedly high or low figures. This way you can be sure that it is not an error, or that nothing is being hidden. The same goes for complex internal and external transactions. If these cannot be explained, or do not have a sound economic basis, we recommend investigating them further.

  • How do you follow up on your stocks?

One of the most worrying stock trends is rising inventory, or an increase in the number of accounts receivable compared to your sales. This could be a sign that there will be additional stock write-offs in the future, or that uncollectible debts are likely to arise. If you want to know what the negative effects will be and how you can limit them, you need to analyze these factors to gain an insight into the cause of this increase.

  • How often do you analyze your figures?

In many companies, it is customary to schedule quarterly evaluation interviews. However, it may also be worthwhile to evaluate your most important KPIs at least every four weeks. Some KPIs can even be evaluated on a weekly basis. Make sure to have a useful tool available that clearly displays your figures, allowing you to make a clear analysis of the situation. If you leave this too long, you will not be able to make good decisions

  • How digitized is your business?

Much has been written about dashboards, but do not underestimate the power of a good tool. Smart software can help you correctly estimate average payment terms, what revenue to expect, the condition of your stock, whether staff recruitment are an option, or other new investments. The data at your disposal detail your own history. Information allows you to not only draw smart conclusions, but also to evaluate whether your company is financially healthy. It goes without saying that a clear overview supported by visual information will help you with this.

Conclusion

It often requires a great deal of technical knowledge to detect, investigate and resolve elements of concern. We recommend reporting as accurately as possible and introducing sufficient checks and balances to ensure that errors or inaccuracies do not creep into your financial reports. A change in accounting package often provides opportunities for clearer reports, allows for a more structured financial department and – generally – means more options for data analysis can be created. Is collecting more accurate information your goal? Make sure to have proper guidance in the process, because obtaining and understanding the correct information really is the only way to make healthy and successful decisions for your business.

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