The importance of financial health

Financial control is a primary asset, although in most cases it is considered the company’s main problem

by | Dec 2, 2020

Is it possible to generate profits without considering the financial health of the company? The answer is yes.

Is it possible to manage our finances as an asset and make the most of them without considering the financial health of the company? The answer is no.

Analyzing the corporate ecosystem, it is surprising how many companies do not have continuous and stable control over their financial health. Some of the most relevant aspects to have an adequate control, which also help us to define it, are the following:

Feasibility: It measures the capacity to generate positive results and to assume existing or future payment commitments. This aspect must be measured based on data and real possibilities, since verbal or thoughtful feasibility is neither sufficient nor useful or adequate.

Efficiency: In order to survive, one must have operational efficiency and the way to measure it (from an economic point of view) is with the help of the operating margin indicator. This metric indicates the percentage that profit before interest and taxes (PBIT) represents of total sales. The higher the company’s operating margin, the better, since it means that you are earning more for every euro you make from your sales. The result reveals whether the company’s management is correct and whether the company will be able to overcome the financial obstacles, it encounters along the way.

Liquidity: A detailed forecast is indispensable regarding collections and payments with different scenarios and alternative action plans for financing working capital. A relevant premise in this aspect is that companies are born and die by the cash flow.

Profitability: A company can survive without being profitable for a certain period, thanks to the support of creditors and investors, but, in the long term, it is vital to have profitability. The indicator to measure it is the net margin, which corresponds to the relationship between profits and total income. That is, the net profit divided by the turnover. The higher the net margin, the greater the financial safety margin, which indicates that a company is in a better position to invest its capital as it grows and expands.

To be able to execute the result of a good analysis regarding the financial health of our company, it is indispensable to have the support of the company’s environment.

We must be able to transmit trust to our workers, suppliers, advisors, partners… We must be able to transmit it, with transparency and prudence, where we come from and where we are going. We need our natural allies to build valid solutions.

To contextualize and give an example, a mistake that is often made is the temptation to delay payments or simply not to pay when there are cash flow tensions. This is a practice that many companies have used and is a very attractive approach, but it can lead to a system breakdown because you want to transfer your risk to another agent in the chain.

It is important to prioritize the maintenance of the collection and payment chain. In order to comply with the premises described, it is necessary to follow a continuous contact with our reference banks.

If we focus on the possible management tools, a basic and fundamental aspect for many companies is the capacity of indebtedness and the ceiling they can support. It is important that before covering any payment with a potential debt, we ask ourselves about our business model and review the medium and long-term vision of the company. Asking ourselves if the business model is still valid, if it can absorb the debt plus the losses derived from the management of recent times and for how long it can do so, are necessary questions before making any decision of this type.

As in all areas, the factors that do not depend on us are the most difficult to manage and usually lead to the most significant problems. For this reason, it is important to carry out good financial planning. We will evaluate it according to the moment we can find ourselves.

In times of economic growth, it is necessary to take into account both the financial needs for investments in assets and in working capital, which is the money we have to have in circulation to make the business work. In these periods, working capital needs increase and are very important since we have to pre-finance the increase in purchases, stocks, production and subcontracts derived from the increase in sales.

On the other hand, in times of contraction, it is necessary to be clear about the impact on the cash flow. The reduction of the business volume implies less sales and income, and many times a lengthening of the payment terms of our clients. This fact implies a lower availability to finance a business that asks for longer financing terms.

Regardless of the era in which we find ourselves – returning to a previously highlighted concept – for a viable company, there are always solutions if problems are addressed in time. If, on the contrary, this viability does not exist, or the current (or future) debt is not digestible, it is important to face the situation and analyze with sufficient temporality other more complex alternatives than a refinancing, which can make the company viable. To try to encourage the effort to achieve permanent viability, companies have to decide which maintenance plan they want to follow.

There is a PREVENTIVE maintenance plan and a CORRECTIVE maintenance plan. The main difference between the two is in their nature. While the first one is dedicated to identify the problems in advance and to preserve its initial state, the second one is destined to solve an error when it has already occurred, and then, to try to return it to its initial state.

The optimal choice (whenever possible) is to choose a Preventive Maintenance Plan. Prevention will always avoid costs and therefore will be “cheaper” than correction.

In order for the financial situation to be an asset and not a slab, the monitoring of the cash flow should be daily. As Albert Einstein said: “We have to know the rules of the game and then play better than anyone else”.