All commercial operations are set up for the purpose of making a profit. Therefore, the first ratio to measure the financial health of a company is its profit margin. In layman’s terms, there is always a cost to doing business. This can come from purchasing raw materials to paying taxes or payroll. The difference between the gross profit and operating expenses is the profit margin. The profit margin is also descried as the amount of money the company makes (such as in a quarter) as a percentage of the sales. All stakeholders will be highly interested in high profit margins as it means that they can get more dividends or even have enough financial resources to expand and achieve their vision and goals.
Investors and potential acquirers, however, will be more interested in earnings before interest, taxes, depreciation, and amortization (EBITDA). This financial health metric is a more accurate picture of a company’s profitability because it accounts for financing and capital expenditures. Therefore, a business venture with a high EBITIDA as it is a measure of its high profitability. Furthermore, it is a metric that shows the company has no cash flow problems. However, EBITIDA is not a good metric to measure the worth of a company because it might make it look less expensive that it actually is. This situation is disadvantageous to all stakeholders performing a company valuation for the purpose of selling it or when they want to go public.
Delegate your assignment to our experts and they will do the rest.
However, when the company is small or has a large vision, then its growth will be inevitable. Growing businesses are admirable and are used as case studies of successful business model. The growth process, however, has to be financed in some way. Therefore, the debt-to-equity ratio is a metric to gauge the company’s debt capacity. In other words, a lower debt-to-equity ratio is preferrable (at least 2-to-1) because it tells how much additional debt the company can assume. Lenders and banks are among the few stakeholders interested in the company’s debt-to-equity ratio. Shareholders would also be interested in their company’s debt-to-equity ratio when they are planning for an expansion.
For a company to succeed long enough to achieve its goals, however, it has to be liquid enough to meet its daily obligations or help out in emergency situations. The current ratio is, therefore, a good financial health metric to measure a company’s short-term liquidity. The current ratio tells shareholders, owners, business partners, and banks how many current assets can be used to pay the company’s debt. A current ratio between 1.5 – 2.0 considered healthy for a company.
Lastly, companies do not operate independently. To succeed, they will have to depend on other suppliers and vendors. Furthermore, the company might be offering products and services to other companies and businesses. Therefore, the accounts receivable days is a financial metric to judge the strength of the company’s cash flow. In other words, the fewer the days it takes to collect the accounts receivable, the better the financial health for the company. However, the standard number of accounts receivable days is industry dependent. Therefore, company management would be interested in fewer accounts receivable days as it would strengthen the company’s financial position.
