Financial Health Rating: How Are Businesses Doing Financially?

A company’s current financial health rests on how it managed its cash reserves in the past. A financial health rating is a single measure – from 0-100 – that indicates the overall financial wellness of a particular organization. The better the money is handled now, the healthier will be the future financial health rating.

Unlike narrow metrics, such as credit scores, financial health rating helps determine how businesses are saving, spending, planning, and borrowing and whether these decisions align with the overall financial targets. This holistic analysis provides an accurate picture of organizations’ ability to navigate financial stressors and reach their long-term goals.

If, for instance, a firm has scored:

• 0-39 points: It is financially vulnerable.

• 40-79 points: It is financially coping.

• 80-100 points: It is financially healthy.

The motive here is not to regret or criticize the past but to understand an enterprise’s financial behavior. Financial health rating helps companies reconsider some of their financial decisions or align their behavior to their goals over the long haul.

Why Should Businesses Know their Financial Health Rating?

Understanding a company’s financial wellness is crucial for all professionals - business owners, entrepreneurs, employees, and stakeholders. Calculating financial health ratings empowers enterprises to make well-aware decisions about their roadmap and how they allocate the resources for essential and non-essential needs. Additionally, such analyses help determine the areas that demand immediate healing to maintain a robust financial track.

Conducting financial health checks enable businesses to negotiate obstacles while looking for loans, such as fulfilling the eligibility criteria and strengthening repayment ability. By assessing the financial report data, decision-makers can know their organizations’ fiscal health and turn that data into actionable insights favoring the business.

How to Measure Financial Health Rating?

Following are some key factors organizations must examine while measuring their financial health rating:

Balance Sheets

Balance sheets help organizations examine their financial position at a specific time frame. It underlines a firm’s assets, liabilities, and owner’s equity.

Assets are the entities that companies utilize for business operations. Liabilities represent the repayable cash that companies have borrowed from other sources. Finally, owner’s equity refers to the financing that owners – public or private – have invested in the business.

Assets should always amount to the sum of liabilities and owner’s equity, i.e.,

Assets = Liabilities + Owner’s Equity

Analyzing balance sheets helps companies determine the time they take to sell their on-hand inventory, the existing debt against the equity (debt-equity ratio), and short-term liquidity.

Income Statements

Income statements indicate organizations’ financial performance over a time frame by focusing on their revenues, expenses, and profits earned. Management can devise their income statements for any time bracket using a trial balance of transactions from any two points in the particular period.

By evaluating income statements, businesses can learn about their gross profit margin (GPM) for deliverables sold, revenue growth over specific accounting periods, and net profit after bearing all expenses.

Cash Flows

Cash flow is the enterprises’ money movement during an accounting period and is a critical metric for financial health rating. Conducting cash flow tests helps examine whether the money entering and leaving companies is well-balanced. Else, the company might slip into a financial risk situation.

A low cash flow suggests tough times for paying creditors, employees, and suppliers. Assessing it in advance helps organizations take necessary measures for crisis abatement.

Financial Ratios

Financial ratios help tease out value from the numbers in financial records and are effective tools for determining companies’ overall financial wellness. These ratios come under multiple categories: liquidity, profitability, efficiency, solvency, and valuation.

Critical financial ratios include return on equity (ROE), GPM, debt-equity (D/E) ratio, and total asset turnover. Enterprises should compare financial ratios across periods and against peers to check if they are improving or declining and how they are surviving against direct and indirect industry rivals. No single ratio is adequate to gauge organizations’ financial health ratings. Instead, they should utilize a blend of ratio evaluations across all statements.