While investing in a company, assessing its financial health helps you know if it is stable and has enough money to continue its business. However, doing that involves examining the financial status across various aspects and parameters. If you are looking to invest in a company but are unable to decide, evaluating its financial health can help make things easier. Financial checks form part of our stock market classes. However, this blog will give you a basic idea of it.
5 Things to Check While Assessing a Company’s Financial Health
Before you invest in a company, you must check if it is good to invest in it. An important factor here is its financial standing. Analyzing the below factors will help you make an informed decision.
1. Cash Flows
Cash is the lifeline of every business. It helps a company meet its expenses, etc Thus, the first thing you must do is check a company’s cash flows. A company may look profitable on paper. However, if it has cash flow problems, then it may face serious challenges in the future.
Accordingly, you must analyze a company’s recent cash flow statements to understand how much cash the company generates and uses across various areas of its business. A positive cash flow is a solid indicator of a company’s financial health. It shows the company has enough money to survive.
2. Balance Sheet and Income Statement
Income statements provide an overview of a company’s revenue, profit, and expenses over a particular period. Thus, you must look for consistent revenue growth and controlled expenses while assessing a company’s financial health. Additionally, you should check the company’s balance sheet as it provides information about a company’s assets against its liabilities. A company that balances both shows that its financial health is good.
3. Liquidity
Liquidity refers to the amount of cash and assets that can be easily converted to cash to fulfill a company’s short-term debt liabilities. The two common parameters to measure liquidity include current and quick ratio.
To measure the current ratio, you must divide the company’s current assets by its current liabilities. A current ratio above 1 shows that a company has more assets than liabilities. However, a very high current ratio shows that the business isn’t using its resources effectively.
On the other hand, the quick ratio is also called the acid test. It is calculated by current assets minus inventory divided by current liabilities.
4. Operating Efficiency
Another factor is to assess how efficiently a company uses its assets or capital.
For example, there are two companies A and B with assets Rs. 10 crore each. Company A produces Rs.3 crores in sales and B generates Rs. 5 crores. Now, when you talk of operating efficiency, A’s assets are 30 percent efficient, and B’s 50 percent efficient. Thus, company B is better than A. As an investor, you must look for companies with the highest operating efficiency.
Learning how to calculate the operating efficiency with various ratios requires learning stock market basics. Joining our stock market classes can help you do it.
5. Profitability
Every company operates to generate profits. However, calculating a business’s profitability could be a little tricky. Let’s understand it through a simple example.
Let’s see you are reviewing two companies A and B. A generates Rs. 10 crores as a net profit, whereas B produces Rs. 1 crore. Now, you might think A is more profitable. But is that really the case? Maybe not! Here, you must look at a company’s total income. So, if A’s total income is Rs. 1000 crores, its profitability is only 0.01 percent. B’s total income is 10 crores. Thus, its profitability at 10 percent is much better than A. So, from the profitability percentage, B is better than A.
Final Words!
Every company operates to generate profits. However, calculating a business’s profitability could be a little tricky. Let’s understand it through a simple example.Do you want to learn how to make profitable investment decisions and need guidance for it? Join Wealth Note! While running stock market courses, we also guide people in opening Demat accounts, making informed choices, providing IPO assistance, and helping you understand various investment options like stocks, structured products, derivatives, commodities, and currencies.
Additionally, our services include making better mutual funds, bonds, debenture, and insurance choices. Our portfolio management services (PMS) help you manage your portfolio and meet your financial goals systematically. We provide 100 percent knowledge-based advisory, lifetime support, and portfolio rebalancing services to help you keep your portfolio balanced. Do you want to know more about our services or stock market courses? Call us at +91 70666 66464 and connect with our experts.