How to check if a company is doing well financially

Whether you’re looking to invest in a new business venture or are looking for a new business partnership, being able to get your hands on the business’s financial information by performing a company financial check is imperative to your next financial decision. Yes, seeing high revenue figures can be convincing; however, there are also times when there are underlying health issues, such as large amounts of debt or poor cash flow. 

Here, we’ll simplify the complex concept of corporate finance by giving you a clear, step-by-step process of how to identify a company worth investing in. 

The big three in a company's financial check 

There are three main financial statements to look at in detail when looking to find out whether or not it is worth investing in. These are: 

  • The balance sheet: Looking at what a company owns (assets) versus what it owes (liabilities) is important information to have. 
  • The income statement: This will show whether or not a company is making a profit over a specific period of time (either quarterly or annually)
  • The cash flow statement: This statement tracks the actual cash flow of the business, looking at when cash moves in and out of the company. 

Once you have an idea of the company’s most important three financial statements, you can make an informed decision for yourself. 

Checking the vital signs

The good news is that you don’t need to be an accountant to run a basic company financial check. Instead, you can look at the following vital signs to help you with your decision. These are things that you need to look out for on top of doing research on the three financial statements discussed above. 

Liquidity: Can they pay the bills today?

Unfortunately, when conducting a financial check on a company, the company can look profitable on paper, but still go bust if it can’t pay back its suppliers. To be able to successfully find out if a company is profitable, is to look at the current ratio between its current assets and liabilities. 

Divide the current assets by the current liabilities. Having a ratio between 1.5 and 2 is generally considered healthy, and anything between 1 means that the company is struggling to meet their financial obligations. 

Profitability: Is the engine efficient?

Essentially, revenue is what a company collects, and profit is what it keeps once all its expenses are paid. 

  • Net profit margin: Looking at the net profit margin lets you know how much money the business has actually earned after all its expenses have been paid. 
  • The goal: So, the aim here is to look for a margin that is either steady or increasing. If the revenue is increasing but the profit margins are shrinking, this means that the company is more expensive to run, making it unworthy of your time. 

Solvency: Is the debt manageable?

It’s important to note that debt isn’t always a bad thing and that, sometimes, it can fund growth. However, if there is too much debt, this is when it becomes an issue. 

So, the idea here is to look at the debt-to-equity ratio when doing a financial check on a company. This measures how much the company relies on loans, versus its own money. Typically, a lower ratio indicates a more stable and less risky business.

Operating cash flow: Where is the money coming from?

A red flag when implementing any financial check on a company is paper profit without cash. So, to ensure you understand the full picture, you need to ensure that the company is generating cash from its core operations and not purely from selling off equipment or taking out new loans. When a business has positive operating cash flow, it can be seen as the ultimate sign of a self-sustaining business.

Red flags to watch for with a financial check on a company 

The deeper you go into your financial check on a company, make sure you keep an eye out for specific red flags, for example: 

  • Frequent auditor changes: This may signal disputes over how a company reports its numbers 
  • Declining inventory turnover: Having goods sitting in a warehouse shows that the products are losing their market appeal. 
  • Rising accounts receivable: if the money owed by customers is growing a lot faster than the business’s sales, then this shows that the company might be struggling to collect the cash it is earning. 

Look for trends

An important part of implementing a financial check on a company is to look at the past 3-5 years of the company. Looking only at the past year will not give you an accurate representation of how the company is doing financially. Ask yourself: Is the revenue growth consistent in the company? Is the debt of the company decreasing? And, are they reinvesting in themselves? 

Summary checklist

Here’s a summary of all the things you should be looking out for when conducting a financial check on a company to ensure it is worth investing in. 

Area

Metric to check

Green flag

Short-term health

Current ratio

Above 1

Efficiency

Net profit margin

Growing or stable

Stability

Debt-to-equity

Low compared to peers

Survival

Operating cash flow

Consistently positive

Performing a thorough financial check on a company will take time, but it is one of the most important things that you will need to do to ensure you protect your own finances and investments.

At Creditserve, we help you find out everything you need to know about a company’s credit history, allowing you to make informed decisions about your next business decision. For more information on next steps, get in touch with our team of experts today!