Evaluate the financial health of a company: method and process

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The financial solvency of a company is an element that should not be neglected when entering into a partnership with a supplier, for example. If you are not solvent, your business relationships will be more complex to form.

What is solvency?

The solvency means that a company can honor its debts, whatever the due date. Why is solvency useful to assess the financial health of a company ?

  • Creditworthiness is an essential element in knowing whether a company is in good financial health.
  • A solvent company can establish commercial relations and thus ensure its development. For example, the possibility of concluding a contract with a supplier. The ability to pay taxes and face other charges.

It is important to distinguish between short-term and long-term solvency. If a company is solvent at a specific time and you decide to enter into a business relationship with it, it is important to ensure that this will be the case in the long term as well.

What are the indicators?

Cash

The cash flow of a business is the amount available in the bank or in cash. If it is more important than its debts, we can say that it is solvent. This indicator shows that the company has liquidity which can be seen as collateral because the company can face many expenses without resorting to bank loan. This can be the payment of its supplier invoices or its fixed charges (rents, energy, etc.).

Thus, the greater your cash flow, the more you will have to attract new partners and you will be identified as a reliable company.

Earnings

Profit is a very important indicator because it will allow you to build up your cash flow. The profit results from a positive accounting result; in other words, the company can generate cash in a sustainable way. Unlike the turnover which only retains the receipts; the profit also takes into account the charges. Thus, the turnover can increase without the profit following the same trend, one speaks then of negative accounting result and therefore of a loss-making company. If your profit increases year over year, then you are on the right track.



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