Money can’t buy happiness, but it sure can affect your physical wellbeing. Much like taking care of your physical health, taking care of your financial health is equally important. That means you have to keep checking on your business health, such as taking care of your financing, and managing income and expenses. If you wish to see your business prosper long into the future. Here’s a guide on how to keep checking on your financial health, also you can click here to learn more.
- 1 What is financial health?
- 2 Importance of taking care of financial health
- 3 Understanding basics of finances
- 4 Keys and steps to evaluate financial health (for non-financials)
- 5 Best ways to measure the financial health of a business
- 6 List of financial indicators for small businesses
- 7 Takeaways for small business
- 8 Bottom line
What is financial health?
It refers to the state of your monetary affairs. It’s the basic measure of the soundness of your finances, a reflection of your financial shape. Most people perceive it as a measure of financial security.
There are many dimensions to it, including:
- Credit rating
- Expenses and debts
- How much you’ve stashed away for retirement
Importance of taking care of financial health
According to a Financial Health Pulse 2020 Trends Report, only 30% of Americans felt financially healthy. Such a sad state of affairs causes people to worry more about money than their physical health or love lives. This is a surefire route to anxiety and stress-related illnesses. Taking care of your financial health is a recipe for a happy and successful life. In addition, getting your finances in shape means more financial independence and freedom as you are in control of your finances. You have more confidence in meeting short and long-term goals.
Understanding basics of finances
It’s not essential to master finance, but there are a few basics that you should be aware of – call them the four pillars of personal finance:
1. Managing income and expenses
This should be the first step in your journey to financial health. Track your income and expenses religiously, and a budget can go a long way in helping you achieve this
Savings refer to the surplus money stashed away for future use. You could use it for investing or for huge expenses such as your home. A common channel for investing is money market securities.
Involves purchasing assets that will generate returns more significant than what you invested, although not all investments are profitable. Investments include stocks, mutual funds, and real estate.
Emergencies can happen suddenly, wreaking havoc on your finances. Such products include health and life insurance. Another form of protection is retirement plans, such as 401(k) and 403(b) plans.
Keys and steps to evaluate financial health (for non-financials)
You can’t fix something you’ve no idea is broken, so a financial health evaluation should help determine if you need to plug any holes. First, assess how much money you have by adding up all your assets. These include cars, cash in financial institutions and retirement accounts, real estate holdings, and current home value. Secondly, calculate your debts such as small business financing, credit card balances, and mortgage balance.
Finally, subtract the debts from the assets to find your net worth. A debt-to-income ratio will help you discover how much debt eats into your income. Calculate all your monthly debt payments, including loans, credit card bills, and rent or mortgage payments. Divide the total debt by your monthly income.
From the answer, move the decimal point two places to the right to find your debt-to-income ratio. As per experts’ recommendation, a 30% or lower figure is healthy–anything higher means you have to supplement your income or find ways to lower expenses.
Best ways to measure the financial health of a business
Your best bet of achieving this lies in analyzing several books of accounts.
1. Measure liquidity
This will reveal the ability of a business to pay short and long-term obligations by considering current assets and liabilities–they give you a picture of its likelihood of surviving. Some standard methods of gauging this include the acid test ratio and current ratio.
How efficiently a business utilizes its assets is a key pointer to good financial health. The best indicator for this is operating margin as it proves how well management is controlling costs. You derive operating margin by dividing operating income by net sales.
Solvency refers to your business’s ability to pay debt obligations in the short and long term. You can also use it to gauge a company’s attractiveness to investors. The most common indicator used is the debt-to-equity (D/E) ratio. A low D/E ratio means the business is treading on solid financial ground.
This is the most important indicator because no company will survive for long without profitability. The best benchmark to use is net margin, which measures net profit generation by dividing net profit by net sales. A sizable net margin indicates excellent financial safety.
List of financial indicators for small businesses
These are the key financial indicators you should be tracking:
- Liquidity: how easily does the business handle short-term obligations?
- Activity: is everyone managing assets effectively?
- Profitability: comparatively speaking, are you making as much profit as others in your space?
- Leverage: can you finance to grow effectively?
- Growth: What are your sales and profits figures? Are they expanding or decreasing?
Takeaways for small business
Firstly, invest in growth. Always try to set aside cash for exploiting growth opportunities when they present themselves. You will increase the value of your business if customers and employees see you investing in improved service delivery. Take out good credit to push the business in the right direction. Don’t be afraid to take loans if it can nudge the company towards profitability–hunt for loans that offer the best interest rates.
That said, you have to keep a close eye on the financial books. In particular, focus on expenditure and your return on investment (ROI). Keep good financial habits. It’s tempting to splash the cash when the business starts pulling in some profits, but that is a surefire way to financial ruin. Update and review financial information and place internal financial controls. Plan for all eventualities; think where you want to steer the business in the next 5-10 years.
The one thing that will keep your business running smoothly is sound finances. Therefore, you have to keep checking on your income and costs. Put a lid on wasteful spending while saving for investing and emergencies.
You can use profitability, efficiency, and liquidity financial indicators to determine how your business is doing. Some of the ratios you will use include debt-to-equity ratio, acid test ratio, and net margin ratio.
That said, plan for the future, keep good financial habits, and get good credit, such as small business financing, to ensure your business stays healthy. Visit Camino Financial to learn more about checking financial business health.