How to create a financial health check

Finance teams, accountants and founders can create a comprehensive financial health check by importing financial and non-financial business data into reporting software like Fathom. You could also use spreadsheets that have been custom built, although your results may not be as detailed, timely, or easy to interrogate.

What is a financial health check?

A financial health check is a performance report that combines financial and non-financial data to demonstrate the quality of 3 critical business elements:

• Profit
• Cash
• Enterprise value

Understanding the core principles of a financial health check

A financial health check leverages 4 core principles to deliver business insight:

1. A connection between drivers and outcomes: examining causal links between operational drivers and business results
2. A combination of financial and non-financial measures: integrating non-financial drivers with financial metrics to identify meaningful areas for improvement or opportunity
3. Interconnectivity of critical elements: analysing how operating profit, free cash flow and value creation behave in relation to each other, not just in isolation
4. Circularity of business intelligence: generating insights that support sustainable decision-making, investment and growth strategies

Why should you do a financial health check?

A financial health check is a key diagnostic and decision-making tool for a business. A high-quality report will enable you to:

• Develop awareness of what really matters to operate a business beyond survival  
• Have a clear and timely understanding of changes in profit, cash flow and value
• Always be lender- and investor-ready. A financial health check highlights the positioning of the business in key areas of interest to these parties
• Have the correct financial data to manage covenants required by providers of debt or equity capital. (Dissatisfied providers of debt capital represent one of the most significant risk factors for a business)
• Create a foundation for developing growth targets and a strategic financial plan
• Measure outcomes against strategic goals, benchmarks and survival thresholds

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“Businesses are not about the numbers; they are about the people. But the numbers are what make or break success. I recommend financial health checks for any business looking to grow beyond the survival level. And, in my view, Fathom offers the best capability of any reporting software on the market.”

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What data do you need for a financial health check?

The minimum data required are:

• Detailed annual financial statements for 2 years
• Detailed monthly financial statements produced, from software like Quickbooks, Xero or MYOB
• Current budgeted financial statements for the year
• Non-financial data considered to be relevant and meaningful as drivers of profit, cash and value (select no more than 2 non-financial drivers for each category)

What financial data should you include?

You will need to include a diverse range of metrics that help indicate the financial health of the business.

Here are some examples of common financial health check metrics.  

Profitability metrics

Put very simply, profitability metrics reveal how much income the company has left after accounting for expenditure. There are many different ways to look at this, but some meaningful profitability metrics include:

• Gross profit margin %  
• EBITDA % (earnings before interest, tax, depreciation and amortisation)  
• NPAT % (net profit after tax and interest)
• NOPAT% (the net operating profit after tax but before interest)  
• Break-even revenue, where operating profit is zero

Learn about Fathom’s profitability tool ->

Cash flow and funding metrics

Cash flow is the life blood of all businesses. It is driven from a number of key elements that need to be managed interconnectedly to create a sustainable cash flow stream.  

Equally important, a company’s ability to service its debt funding obligations – or its potential to deliver a return to providers of equity capital – must be monitored.

Cash flow forecasting and funding metrics include:

• Operating cash flow  
• Net cash flow  
• Free cash flow  
• Breaches of bank covenants  
• Debt:equity ratio

Learn about Fathom’s cash flow tool ->

Liquidity metrics

Every business has a liquidity cycle that is naturally developed from operating activities. The common cycle is based on conversion and transformation processes.  

In other words, cash is transformed into inventory, which – when sold – converts to accounts receivable, and then finally back to cash after meeting trade credit obligations.  

The relationship between data such as the metrics below becomes an integral part of the liquidity cycle.

• Activity %
• Current ratio
• Accounts receivable days outstanding
• Inventory days of materials or product held
• Accounts payable days outstanding

Return on investment metrics

Return on investment (ROI) metrics combine multiple input and output metrics to show how efficiently and effectively a company generates its profit from the operating capital invested in the business.

They can be complex, as they require a clear understanding of various underlying data points; however, when calculated properly, they offer a powerful picture of a company’s profitability that can be benchmarked against other businesses in an accurate and meaningful manner.  

They are also commonly used to develop strategic financial management pathways.

ROI metrics include:

• Return on equity %
• Return on invested capital %
• The performance gap against the cost of capital – WACC %
• The economic value added (EVA)

What non-financial data should you include?

Non-financial business data are any metrics that provide insights into a company’s strategic and operational performance as a correlated driver of profit, cash or value.  

They are often harder to collate and report on than financial measures, but the effort taken is well worth it when it comes to interpreting your financial health check report.

Learn how to import non-financial data into Fathom and create non-financial KPIs ->

Here are some useful non-financial business data examples.

Metrics for operational performance

Metrics for operational performance should focus on measuring a company’s day-to-day operations and processes. This might include activities and areas such as:

• Efficiency – production cycle time, inventory turnover, delivery on time and in full, re-work
• Productivity – employee productivity (output per hour worked), and other input: output measures
• Quality – assurance, re-work, returns

Metrics for customer satisfaction

Metrics for customer satisfaction should gauge a company’s relationship with its customers and how happy they are with a product or service. They might include:

• Customer satisfaction – measured through surveys and feedback channels
• Customer retention – percentage of repeat customers
• Net promoter score (NPS) – a measure of customer loyalty and willingness to recommend the company to others
• Delivery in full and on time as promised (DIFOT) %

Metrics for employee outcomes

It is also important to assess metrics such as the performance, engagement and wellbeing of employees. Common metrics are:

• Employee satisfaction – similar to customer satisfaction, but focused on workforce
• Employee turnover rate – percentage of employees who leave a company within a given period
• Training and development – capability building opportunities provided to and completed by employees
• Workplace health and safety metrics

How do you validate input data quality?

To have confidence in your outcomes, it is essential to validate your input data.

Review all input data used to populate your model for quality and best practice. You must be satisfied that the accounting function is reliable.

Accounting records should be up to date with consistent rules governing data entry. Ideally, user-friendly and cost-effective accounting software such as Quickbooks, Xero or MYOB will have been used to produce high-quality data.

You also need a high level of confidence in matching the income and expenditure, as displayed on the income statement. Detailed elements supporting the classification of assets, liabilities and equity in the balance sheet should be carefully examined.

Why is it important to normalise data?

Normalising data is important because it brings different scales of data into a consistent format so that comparisons are meaningful. Without these adjustments, analysis, trends and ratios can be distorted in your financial health check.

There are 2 main types of data that you may need to normalise:

• Abnormal data – this is data that falls outside the expected pattern. You can identify it fairly easily by analysing the normal range of operations. Typically, you must then decide whether to exclude, correct or disclose it. Abnormal data often reflect an error or an anomaly in the accounts.
• Non-recurring data – this is normally the outcome of events that are not expected to occur again or regularly. They are usually legitimate, but do not reflect ongoing business performance. Because a financial health check is all about getting a clearer view of sustainable results, non-recurring data should therefore also be excluded, corrected or disclosed.

Next step: How do you interpret the data?

Once you have created your report, you will need to know how to understand and use the information.  

Learn more in André’s next article: How to interpret a financial health check.

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