Financial strength is a company’s ability to generate revenue and have sufficient cash flow. It helps a company grow and return capital to owners.
In this article, you’ll discover why financial strength is important and how to measure it. We’ll also review the 6 steps to financial strength.
Why is financial strength important?
Entrepreneurs who own a startup or a well-established company strive to generate more sales to increase their revenues and make a business successful. However, they are mistaken in thinking that they can establish financial strength in this way. Financial strength is different from the concept of profitability. Financial strength encompasses the ability to generate revenue, have sufficient cash flow, financial competence, and return money to investors.
Business owners care about financial strength since it’s one of the main components of a successful company. That’s why they care about the business’ sales and financial performance. Since finance is crucial for achieving success, profitability, and growth, marketers keep an eye on the cash flows, bills, and debts.
Now that you know why financial strength is important, let’s review how to measure the financial strength of your company.
How to measure the financial strength of a company?
Evaluating the financial health of a business is essential for every brand owner. In this section, we’ll uncover how to do it.
- Estimate liquidity. It’s one of the main factors that influence the financial strength of a company. Liquidity is the amount of cash or assets a brand uses to pay its short-term debts. To evaluate this indicator, use the current ratio metric. It shows the ability of a business to pay short-term obligations. With its help, investors can find out how a company can use its current assets to pay its current debts. To calculate the metric, you should divide the current assets by current liabilities.
- Identify solvency. This concept is closely related to liquidity since it shows the ability of your business to fulfill its debt obligations daily. After calculating the measure, you’ll find out your company’s long-term debt concerning its equity. Once you use the debt-to-equity ratio formula, you’ll unveil how your business operates and whether it depends on debts or wholly-owned funds. To calculate the measure, you need to divide your company’s total liabilities by shareholder equity.
- Evaluate operating efficiency. To identify one of the most critical factors for your company, you need an operating margin metric. This measure helps figure out the revenue your business earns after paying variable costs but before you pay tax or interest. To estimate this measure, divide your company’s operating income by its net sales.
- Get to know profitability. In the short run, companies can exist for some time without being profitable. However, to survive and prosper in the long run, they need to bring good profits to their owners. Hence, consider using net margin to estimate your company’s profitability. It shows how much net income your business receives as a percentage of revenue.
Now that you know how to measure the financial strength of a company, it’s time to discover six steps to financial strength.
6 Steps to Financial Strength
If you want to build financial strength for your business, consider the following steps. Let’s take a closer look at them.
- Review your financial statements. Since the financial health of your company has a big impact on the further success of your business, it’s necessary to have a track of financial statements, budgets, ratios, and accounting. As an entrepreneur, you should regularly create a budget and compare it with actual results. Once you know the financial condition of your business, you’ll be able to make more accurate and relevant business decisions.
- Hire an accountant. If you don’t have strong accounting knowledge and skills, it’s an excellent idea to find a professional accountant. This person will assist you in managing your company’s finances. Besides, a good accountant will help you avoid financial problems.
- Send invoices fast. Some entrepreneurs postpone and send their invoices once a month or even less often. Yet it’s a wrong cash flow practice for your business. After completing the order and delivering a product to the customer, you should immediately send the invoice.
- Collect payments on time. Once customers receive your invoice but still don’t pay, contact them to inform them about the payment. Consider sending a reminder before the due date and repeat the action if customers don’t react.
- Reduce expenses. You need to monitor and manage your costs efficiently. As a business owner, you should search for different ways to cut down your expenses. For instance, ask vendors to make volume discounts or reduce shipping costs. As an option, consider using technology to reduce overhead expenses.
- Prevent cash flow shortfalls. Sometimes businesses might experience a cash crunch. To avoid this scenario, monitor the cash flow within your company and prepare a plan. If a cash crunch happens, you should know what to do. The first thing you should do is receive financing, such as a factoring line. As a result, you’ll be able to get cash from your accounts receivables without waiting.
Congrats, now you know the ways to measure financial strength and the six steps to financial strength. Hope our information will come in handy once you decide to take care of the financial condition of your company.
Last Updated: 22.03.2023